As filed with the Securities and Exchange Commission on February 5, 2001
Registration No. 333-52726
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 1
TO
FORM S-4
REGISTRATION STATEMENT UNDER THE
SECURITIES ACT OF 1933
CII FINANCIAL, INC.
(Exact name of Registrant as specified in its charter)
California 6719 95-4188244
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification Number)
2716 North Tenaya Way
Las Vegas, Nevada 89128
(702) 242-7040
(Name and address, including zip code, and telephone number,
including area code, of Registrant's principal executive
offices)
David Sonenstein, Esq.
General Counsel
2716 North Tenaya Way
Las Vegas, Nevada 89128
(702) 242-7046
(Name and address, including zip code, and telephone number,
including area code, of agent for service)
Copies to:
Stephen P. Farrell, Esq.
Howard A. Kenny, Esq.
Morgan, Lewis & Bockius LLP
101 Park Avenue
New York, New York 10178
(212) 309-6000
Approximate date of commencement of proposed sale to the public: As
soon as practicable after this Registration Statement is declared effective in
connection with the exchange offer described in the prospectus contained in this
Registration Statement.
If the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. |_|
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. |_|__________
If this Form is a post-effective amendment filed pursuant to Rule
462(d) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. |_| ____________
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The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until this Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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Subject to Completion. Dated February 5, 2001
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PROSPECTUS
AND EXCHANGE
OFFER
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CII FINANCIAL, INC.
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EXCHANGE OFFER FOR ALL OUTSTANDING 7 1/2% CONVERTIBLE SUBORDINATED
DEBENTURES DUE SEPTEMBER 15, 2001 OF CII FINANCIAL, INC. (CUSIP NO. 12551LAB7)
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EXCHANGE OFFER EXPIRATION: February 12, 2001 at 5:00 p.m., New York time.
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EXCHANGE OFFER
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We are offering to exchange your 7 1/2% convertible subordinated debentures
due September 15, 2001 of CII Financial, Inc., under either of the following two
options:
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o
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o o $1,000 in principal amount of new 9% senior
subordinated debentures due September 15, 2006 of CII
Financial for each $1,000 in principal amount of the old
junior subordinated debentures that you tender; or
- ------------
o o $525 in cash for each $1,000 in principal amount of the old junior
subordinated debentures that you tender, up to a maximum of $19,500,000 in
aggregate principal amount of old junior subordinated debentures. If the cash
option is oversubscribed, holders who elect the cash option will be permitted to
sell a prorated amount of their old junior subordinated debentures for cash and
we will exchange the balance of old junior subordinated debentures we receive
for new senior subordinated debentures.
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We will pay the interest on all old junior subordinated debentures
accepted in the exchange offer to, but not including, the date of
acceptance.
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We have applied to list the new senior subordinated debentures on
the New York Stock Exchange.
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The exchange offer is subject to the following material conditions:
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o valid tenders of at least 90% of the aggregate principal amount of the
old junior subordinated debentures;
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o the receipt of the consent of the lenders under the $135
million senior secured credit facility of our parent,
Sierra Health Services, Inc., which has been irrevocably
and unconditionally guaranteed by us, to the issuance by
us of the new senior subordinated debentures in the
exchange offer;
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o the receipt of the approval of the California Department
of Insurance required for one or more of our subsidiaries
to directly or indirectly fund all or part of the cash to
be paid as exchange consideration; and
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o our obtaining sufficient cash to pay any cash required to be paid as
exchange consideration.
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If the conditions of the exchange offer are satisfied or waived by
us, we will accept for exchange any and all old junior subordinated
debentures that are validly tendered and not withdrawn before 5:00
p.m., New York City time, on the expiration date of the exchange
offer. If the conditions are not satisfied or waived or if we
otherwise terminate the exchange offer, tendered old junior
subordinated debentures will be returned, without expense to you.
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Both acceptance and rejection of this exchange offer involve a high
degree of risk. See "Risk Factors" beginning on page 12 of this
prospectus for a discussion of some of the risks you should
consider in evaluating the exchange offer and an investment in the
securities offered through this prospectus.
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Neither the Securities and Exchange Commission nor any state
securities regulator has approved or disapproved these securities,
or determined if this prospectus is adequate or accurate. Any
representation to the contrary is a criminal offense.
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o The exclusive dealer manager for the exchange offer is:
Banc of America Securities LLC
The date of this prospectus is .
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TABLE OF CONTENTS
Page
PROSPECTUS SUMMARY............................................................................................1
RISK FACTORS....................................................................................................12
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS...............................................................18
WHERE YOU CAN FIND ADDITIONAL INFORMATION.......................................................................18
USE OF PROCEEDS.................................................................................................19
CAPITALIZATION..................................................................................................20
THE EXCHANGE OFFER..............................................................................................21
BUSINESS 32
SELECTED FINANCIAL AND OTHER DATA...............................................................................47
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...........................49
MANAGEMENT......................................................................................................60
CERTAIN TRANSACTIONS............................................................................................66
PRINCIPAL STOCKHOLDERS..........................................................................................67
DESCRIPTION OF OTHER INDEBTEDNESS...............................................................................67
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS...........................................................69
DESCRIPTION OF DEBENTURES.......................................................................................85
BOOK-ENTRY SYSTEM-- THE DEPOSITORY TRUST COMPANY................................................................93
MATERIAL UNITED STATES FEDERAL INCOME TAX CONSEQUENCES..........................................................94
LEGAL MATTERS...................................................................................................100
EXPERTS .......................................................................................................100
ANNEX I .......................................................................................................a-1
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS......................................................................f-1
PROSPECTUS SUMMARY
This summary highlights selected information from this prospectus and may not
contain all of the information that is important to you. To understand the
exchange offer fully and for a more complete description of the legal terms of
the exchange offer, you should read carefully this entire prospectus and the
other documents to which we have referred you, including the letter of
transmittal accompanying this prospectus. Unless otherwise indicated, "CII
Financial," "we," "us," and "our" refer to CII Financial, Inc. and its
subsidiaries. Although we refer to CII Financial in this manner, CII Financial
is a holding company and conducts all of its operations through its
subsidiaries. CII Financial is the sole obligor on all of the debentures
discussed in this prospectus.
Throughout this prospectus, we sometimes refer to our existing 7 1/2%
convertible subordinated debentures due September 15, 2001 as our "old junior
subordinated debentures," to our new 9% senior subordinated debentures due
September 15, 2006 as our "new senior subordinated debentures" and to those new
senior subordinated debentures and the cash payment offered in exchange for your
old junior subordinated debentures collectively as the "exchange consideration."
CII Financial, Inc.
We are a holding company primarily engaged in writing workers' compensation
insurance in nine western and midwestern states through our wholly owned
subsidiaries, California Indemnity Insurance Company, Commercial Casualty
Insurance Company, Sierra Insurance Company of Texas and CII Insurance Company.
In addition, we have other smaller subsidiaries that we consider immaterial to
our overall results.
Our insurance subsidiaries write workers' compensation insurance in the
states of California, Colorado, Nevada, Texas, Nebraska, Kansas, Missouri, New
Mexico and Utah primarily through independent insurance agents and brokers. We
have licenses in 33 states and the District of Columbia and have applications
pending for licenses in other states. California, Colorado and Nevada
represented approximately 77%, 8%, and 7%, respectively, of our direct written
premiums for the nine months ending September 30, 2000.
We were acquired by Sierra Health Services, Inc. on October 31, 1995 in a
transaction treated as a pooling of interests. However, our old junior
subordinated debentures remain solely our obligation and Sierra has not
guaranteed the debentures. Sierra is a diversified health care services company
that operates health maintenance organizations, indemnity and workers'
compensation insurers, military health programs, preferred provider
organizations and multi-specialty medical groups. When Sierra acquired us, each
share of our common stock was exchanged for .37 of a share of Sierra common
stock and our old junior subordinated debentures became convertible into Sierra
common stock. The old junior subordinated debentures are now convertible into
Sierra common stock at a conversion price of $39.398 per share. As a result,
$1,000 in principal is convertible into 25.382 shares of Sierra common stock.
Based on the closing price of Sierra common stock on December 29, 2000, the
market value of 25.382 shares of Sierra's common stock was $96.45. In August
2000, we became a guarantor of Sierra's $185 million revolving credit facility,
which was subsequently reduced in size to $135 million. At December 31, 2000 the
credit facility was fully drawn and had an outstanding balance of $135 million.
The old junior subordinated debentures and the new senior subordinated
debentures are subordinated to this guaranty of the credit facility debt.
We were incorporated in the State of California on September 15, 1988. The
principal executive offices of CII Financial are located at 2716 North Tenaya
Way, Las Vegas, Nevada 89128, and CII Financial's telephone number at that
address is (702) 242-7040.
Summary Background, Purposes and Effects of the Exchange Offer
CII Financial, as a holding company, has limited sources for cash and is
dependent upon dividends from its subsidiary, California Indemnity Insurance
Company, to meet its debt payment obligations. California Indemnity cannot
currently pay any dividends without prior approval by the California Department
of Insurance. In addition, CII Financial, as a holding company and sole obligor
under the old junior subordinated debentures, has no available source of cash
with which to pay the old junior subordinated debentures when they mature on
September 15, 2001. Due to the foregoing, we are making this exchange offer in
an effort to extend the maturity date and reduce our indebtedness.
Summary of the Exchange Offer
The Old Junior Subordinated Debentures: We are making the exchange offer
with respect to the entire $47,059,000 aggregate principal amount of our old
junior subordinated debentures, CUSIP No. 12551LAB7.
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The Exchange Offer: We are offering to acquire your
old junior subordinated debentures
in exchange for:
o $1,000 in principal amount
of new senior subordinated
debentures for each $1,000
in principal amount of old
junior subordinated
debentures that you
tender; or
o $525 in cash for each
$1,000 in principal amount
of old junior subordinated
debentures that you
tender, up to a maximum of
$19,500,000 aggregate
principal amount of old
junior subordinated
debentures as described
below.
We are only offering to purchase a
maximum of $19,500,000 aggregate
principal amount of old junior
subordinated debentures for cash.
If holders of more than
$19,500,000 aggregate principal
amount of old junior subordinated
debentures elect the cash option,
we will not have enough cash to
pay for all the debentures that
holders elect to sell. In that
case, we will purchase a total of
$19,500,000 principal amount of
old junior subordinated debentures
for cash and we will exchange the
balance of the old junior
subordinated debentures we receive
for new senior subordinated
debentures. All holders who elect
the cash option will be permitted
to sell the same fraction of their
old junior subordinated debentures
for cash. This fraction will equal
$19,500,000, divided by the
aggregate principal amount of all
debentures tendered for cash by
all holders. We refer to this as
"oversubscription" of the cash
option.
We will publicly announce whether
the cash option is oversubscribed
and the effect of any required
proration as soon as practicable
after the expiration of the
exchange offer.
You do not have to choose the same
option for all of the old junior
subordinated debentures that you
tender. You do not have to tender
all of your old junior
subordinated debentures to
participate in the exchange offer.
Interest: We will pay in cash accrued and unpaid interest on all old junior
subordinated debentures accepted in the exchange offer to, but not including,
the date of acceptance.
Source of Funds: We intend to fund the cash portion of the exchange
consideration from:
o dividends or other transfers of funds from our operating subsidiaries,
subject to approval by the California Department of Insurance; and
o a loan from an affiliate,
which will be represented
by our demand promissory
note bearing interest at a
rate equal to the then
current interest rate on
Sierra's credit facility.
This promissory note will
rank senior to the new
senior subordinated
debentures and the old
junior subordinated
debentures.
Purpose: We are making the exchange offer for old junior subordinated
debentures to extend the maturity date of the debentures and to reduce
indebtedness.
Expiration of the Exchange Offer: 5:00 p.m. New York time, on February 12,
2001, unless extended.
Exchange Date: The exchange of old junior subordinated debentures for the
exchange consideration will be made promptly following the expiration of the
exchange offer and the satisfaction or waiver of all conditions.
Conditions to the Exchange Offer: The exchange offer is subject to the
following material conditions:
o we must receive valid tenders for at least 90% of
the aggregate principal amount of the old junior subordinated debentures;
o we must receive the
consent of the lenders
under Sierra's senior
secured credit facility,
which has been irrevocably
and unconditionally
guaranteed by us, to our
issuing the new senior
subordinated debentures in
the exchange offer;
o we must receive the
approval of the California
Department of Insurance
required for one or more
of our subsidiaries to
directly or indirectly
fund all or part of the
cash to be paid as the
exchange consideration;
and
o we must obtain sufficient
cash to pay any cash
consideration required to
be paid as exchange offer
consideration.
Subject to satisfaction or waiver
of the conditions, we will accept
for exchange any and all old
junior subordinated debentures
that are validly tendered and not
withdrawn before 5:00 p.m., New
York City time, on the expiration
date of the exchange offer.
However, we reserve the right to:
o delay the acceptance of the old junior subordinated debentures for
exchange;
o terminate the exchange offer;
o extend the expiration date and retain all old junior subordinated
debentures that have been tendered, subject to the right of owners of old junior
subordinated debentures to withdraw their tendered old junior subordinated
debentures;
o refuse to accept the old junior subordinated debentures and return all
old junior subordinated debentures that have been tendered to us; or
o waive any condition or otherwise amend the terms of the exchange offer in
any respect.
Procedures for Tendering Debentures: If you hold your old junior
subordinated debentures in book-entry form, you must request your broker,
dealer, commercial bank, trust company or other nominee to effect the
transaction for you.
If you own old junior subordinated
debentures that are registered in
the name of a broker, dealer,
commercial bank, trust company or
other nominee, you must contact
that broker, dealer, commercial
bank, trust company or other
nominee.
We have arranged to have this
exchange offer eligible for the
Depository Trust Company's, or
DTC's, Automated Tender Offer
Program, or ATOP. DTC participants
that are accepting the exchange
offer must transmit their
acceptance to DTC, which will
verify the acceptance and execute
a book-entry delivery to the
exchange agent's account at DTC.
DTC will then send an agent's
message to the exchange agent for
its acceptance. Delivery of the
agent's message by DTC will
satisfy the terms of the exchange
offer as to the tender of old
junior subordinated debentures.
If you hold physical certificates
evidencing your old junior
subordinated debentures, complete
and sign the enclosed letter of
transmittal, or a manually signed
facsimile thereof, in accordance
with the instructions in that
document, have your signature
guaranteed if required by
Instruction 1 of the letter of
transmittal, and send or deliver
your manually signed letter of
transmittal, or manually signed
facsimile, together with the
certificates evidencing the old
junior subordinated debentures
being tendered and any other
required documents to the exchange
agent.
If you desire to tender old junior
subordinated debentures in the
exchange offer and cannot comply
with the procedures described in
this prospectus for tender or
delivery on a timely basis or if
your old junior subordinated
debentures are not immediately
available, you may tender your old
junior subordinated debentures
using the procedures for
guaranteed delivery described in
this prospectus.
Withdrawal of Tenders of Debentures: You may withdraw your tender of old
junior subordinated debentures at any time prior to the expiration of the
exchange offer, but the exchange consideration will not be payable in respect of
any old junior subordinated debentures so withdrawn. We will not determine and
announce whether the cash option for the exchange consideration has been
oversubscribed until after the expiration of the exchange offer. You will not be
able to withdraw your tender of old junior subordinated debentures once we make
this determination even though it may affect the type of exchange consideration
you will receive in the exchange offer.
Untendered Debentures: If you do not tender your old junior subordinated
debentures, they will remain outstanding. The old junior subordinated debentures
will be subordinated to the new senior subordinated debentures. We will have up
to $182,059,000 of indebtedness that will rank senior to any untendered
debentures, consisting of the new senior subordinated debentures, the credit
facility guaranty and the demand promissory note held by an affiliate. In
addition, as a result of the consummation of the exchange offer, the aggregate
principal amount of the old junior subordinated debentures that are outstanding
will be significantly reduced, which may adversely affect their market price, if
any.
Old junior subordinated debentures
that remain outstanding will
remain convertible into shares of
Sierra common stock at $39.398 per
share. As of close of business on
December 29, 2000, the closing
price of Sierra common stock on
the New York Stock Exchange was
$3.80.
Acceptance of Tendered Debentures and Exchange: Under the terms of the
exchange offer and upon satisfaction or our waiver of the conditions to the
exchange offer, we will accept for exchange old junior subordinated debentures
validly tendered on or prior to the expiration of the exchange offer. You will
only receive the exchange consideration if you validly tender your old junior
subordinated debentures. We will make payment of the exchange consideration for
old junior subordinated debentures validly tendered and accepted for payment by
deposit of the appropriate amount of cash and the appropriate amount of new
senior subordinated debentures with the exchange agent, who will act as agent
for the tendering holders of old junior subordinated debentures. We expect the
exchange will be made on the exchange date described in this prospectus.
Accounting Treatment for the Exchange Offer:
The new senior subordinated
debentures will be recorded at the
carrying amount of the old junior
subordinated debentures less cash
consideration given, if any, and
that amount will be used to
determine the effective interest
rate of the new senior
subordinated debentures.
United States Federal Income Tax Considerations: You are referred to the
discussion about the federal income tax consequences of the exchange offer in
"Material United States Federal Income Tax Consequences." Tax matters
are very
complicated and the tax consequences of the exchange offer to you will depend on
the facts of your own situation. You should consult your own tax advisor for a
full understanding of the tax consequences to you of the exchange offer.
No Appraisal Rights: In connection with the exchange offer, you will not
have any right to dissent or to receive an appraisal of your old junior
subordinated debentures.
Use of Proceeds: Our new senior
subordinated debentures are being
issued only in exchange for your
old junior subordinated
debentures. All old junior
subordinated debentures accepted
by us in the exchange offer will
be canceled. We will not receive
any cash proceeds from the
issuance of new senior
subordinated debentures in the
exchange offer.
"Blue Sky" Compliance: We are not making
this offer to, and we will not
accept tenders from, holders of
old junior subordinated debentures
in any jurisdiction in which this
exchange offer or the acceptance
of old junior subordinated
debentures would not comply with
the applicable securities or "blue
sky" laws of that jurisdiction.
Dealer Manager: Banc of America Securities LLC is serving as exclusive
dealer manager in connection with the exchange offer. Its address and telephone
numbers are set forth on the back cover of this prospectus.
Exchange Agent: Wells Fargo Corporate Trust is serving as exchange agent in
connection with the exchange offer. Its address and telephone numbers are
located on the back cover of this prospectus.
Information Agent: D.F. King & Co., Inc. is serving as the information
agent in connection with the exchange offer. Its address and telephone numbers
are located on the back cover of this prospectus.
Summary Description of New Senior Subordinated Debentures:
The New Senior Subordinated Debentures: Up to $47,059,000 aggregate
principal amount of 9% senior subordinated debentures due September 15, 2006.
Issuer: CII Financial, Inc.
Trustee: Wells Fargo Bank Minnesota, N.A.
Maturity: September 15, 2006
Interest: Interest on the new senior
subordinated debentures will be
payable in cash at a rate of 9%
per year, payable on March 15 and
September 15 of each year,
commencing March 15, 2001.
Ranking: The new senior subordinated
debentures, like the old junior
subordinated debentures, will be
subordinated to all our senior
indebtedness, including our
guaranty of Sierra's credit
facility. However, the new senior
subordinated debentures will rank
senior to any remaining old junior
subordinated debentures.
Optional Redemption: Until September 15, 2001, the new senior subordinated
debentures may be redeemed at our option at any time, from time to time, at a
price equal to $1,007.50 per $1,000 principal amount of the new senior
subordinated debentures, plus accrued and unpaid interest, if any. After
September 15, 2001, the new senior subordinated debentures may be redeemed at
our option at any time, from time to time, at a price equal to $1,000 per $1,000
principal amount of the new senior subordinated debentures, plus accrued and
unpaid interest, if any.
Repurchase at Option of Holders: In the event
of a change in control of CII
Financial, the holders of these
new senior subordinated debentures
may require that we repurchase the
new senior subordinated debentures
at $1,000 per $1,000 principal
amount of the new senior
subordinated debentures, plus
accrued and unpaid interest, if
any.
Listing: We have applied to list the new
senior subordinated debentures on
the New York Stock Exchange.
However, we do not expect the new
senior subordinated debentures to
be listed until after 30 days
following the consummation of the
exchange offer.
Principal Differences Between Old and New Debentures: o The new senior
subordinated debentures will rank senior in right of payment to any old junior
subordinated debentures which are not tendered.
o You will receive a higher
rate of interest on the
new senior subordinated
debentures, which will pay
9% per annum, than on the
old junior subordinated
debentures, which pay 7
1/2% per annum.
o The scheduled maturity
date of the new senior
subordinated debentures is
September 15, 2006, which
is five years later than
September 15, 2001, the
scheduled maturity date of
the old junior
subordinated debentures.
o The new senior
subordinated debentures
will not be convertible
into Sierra common stock.
The old junior
subordinated debentures
are convertible into
Sierra common stock at
$39.398 per share.
Outstanding Indebtedness: As of December 31, 2000, we had $182,059,000 of
indebtedness, consisting of the old junior subordinated debentures and the
credit facility guaranty. After the consummation of the exchange offer, we -
will have up to $145,237,500 of indebtedness that will rank senior to the new
senior subordinated debentures, consisting of the credit facility guaranty and
the demand promissory note held by an affiliate. The amount of indebtedness that
ranks senior to the new senior subordinated debentures will depend on the amount
of old junior subordinated debentures tendered for cash and the amount of cash
we borrow from an affiliate to fund the cash portion of the exchange
consideration. The only indebtedness that will rank junior to the new senior
subordinated debentures will be any old junior subordinated debentures that
remain outstanding after the exchange offer.
Summary Historical Financial and Other Data of CII Financial
The table below presents our selected consolidated financial information
for the periods indicated and at the end of these periods. The consolidated
financial statement information as of December 31, 1999 and 1998 and for the
years ended December 31, 1999, 1998 and 1997 was derived from our consolidated
financial statements included elsewhere in this prospectus. These financial
statements were prepared in accordance with accounting principles generally
accepted in the United States of America, and were audited by Deloitte & Touche
LLP. The consolidated financial statement information at and for the nine months
ended September 30, 2000 and 1999 has been derived from our unaudited
consolidated financial statements included elsewhere in this prospectus. The
unaudited consolidated financial statements have been prepared by us on a basis
consistent with the audited financial statements and include all normal
recurring adjustments necessary for a fair presentation of the information set
forth therein. Operating results for the nine months ended September 30, 2000
are not necessarily indicative of the results that will be achieved for future
periods, including the entire year ending December 31, 2000.
See the Glossary of Selected Insurance Terms annexed to this prospectus for
an explanation of certain of the financial and other items included below.
Nine Months Ended
September 30, Year Ended December 31,
----------------- -----------------------
(dollars in thousands) (dollars in thousands)
2000 1999 1999 1998 1997
---- ---- ---- ---- ----
Income Statement Data:
Direct written premiums $153,034 $106,291 $148,824 $153,914 $135,580
======== ======== ======== ======== ========
Net written premiums $93,857 $60,833 $85,097 $134,147 $130,597
======= ======= ======= ======== ========
Net earned premiums $90,951 $58,254 $82,955 $134,274 $129,197
Net investment income and net 10,757 11,901 15,395 20,229 17,361
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realized gains and losses
Total revenues 101,708 70,155 98,350 154,503 146,558
Total costs and expenses 115,715 58,301 91,255 136,625 135,745
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(Loss) income before
federal income taxes and (14,007) 11,854 7,095 17,878 10,813
extraordinary gain
Federal income tax (benefit) (4,902) 4,815 3,602 4,166 272
--------- ------- ------- -------- ----------
expense
Income before extraordinary gain (9,105) 7,039 3,493 13,712 10,541
Extraordinary gain from debt 654 0 111 48 2
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extinguishment, net of tax
Net (Loss) Income $(8,451) $7,039 $3,604 $13,760 $10,543
======== ====== ====== ======= =======
Combined Ratios:
Loss ratio 92.38% 59.76% 74.08% 70.26% 72.24%
Underwriting expense ratio (1) 28.59% 35.61% 31.45% 28.45% 29.67%
-------- ------ -------- ------ --------
Combined ratio 120.97% 95.37% 105.53% 98.71% 101.91%
======= ====== ======= ====== =======
Balance Sheet Data:
Total cash, cash equivalents and $231,604 $238,864 $226,572 $283,509
invested assets
Total assets 492,852 380,766 404,338 379,880
Total debt 47,059 51,196 50,498 51,251
Total liabilities 434,338 309,669 338,285 305,933
Total stockholder's equity 58,514 71,097 66,053 73,947
.........
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(1) Includes policyholders' dividend ratio of 1.83% for nine months ended
September 30, 2000.
RATIO OF EARNINGS TO FIXED CHARGES
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- ------------------------------------ ----------------------- ------------------
Nine Months Ended For the year Ended December 31,
September 30,
2000 1999 1999 1998 1997 1996 1995
(dollars in thousands) (dollars in thousands)
Pre-tax (loss) income before $(14,007) $11,854 $7,095 $17,878 $10,813 $10,630 $9,083
discontinued operations and
extraordinary gains
Fixed Charges:
Interest expense 2,717 2,751 3,706 4,301 4,091 4,123 4,868
Capitalized interest 0 130 130 0 0 0 0
Interest relating to rental 704 632 867 438 438 542 491
------ ------ ------ ------ ------ ------ ------
expense (1)
Total fixed charges 3,421 3,513 4,703 4,739 4,524 4,665 5,359
Earnings available for fixed $(10,586) $15,367 $11,798 $22,617 $15,342 $15,295 $14,442
charges
Ratio of earnings to fixed charges (3.09x) 4.37x 2.51x 4.77x 3.39x 3.28x 2.69x
- ------------------------------------ ------------ ---------- ---------- ----------- ---------- ------------ ----------
- -------------------------
- ------------------------------------------------------------------------------
(1) The representative interest portion of rental expense was deemed to be
one-third of all rental expense.
Earnings were not sufficient to cover fixed charges during the first nine months
of 2000 by $14,007,000; all other periods had sufficient income to cover
charges.
PRO FORMA RATIO OF EARNINGS TO FIXED CHARGES
- ----------------------------------- ------------ ------------ ------------ ---
Nine Nine Year Nine
Months ----------- Months Ended Months Year
Ended Year Ended Ended December Ended Ended
September December September 31, 1999 September December
30, 2000 31, 1999 30, 2000 30, 2000 31, 1999
Presentation One (1) Presentation Two (2)
Presentation Three (3) (dollars in
thousands) (dollars in thousands) (dollars
in thousands)
Pre-tax (loss) income before $(13,012) $6,907 $(13,747) $5,975 $(14,551) $4,962
discontinued operations and
extraordinary gains
Fixed Charges:
Interest expense 1,382 1,840 2,116 2,772 3,176 4,126
Capitalized interest 0 130 0 130 0 130
Interest relating to rental 704 867 704 867 704 867
------ ------ ------ ------ ------ ------
expense (4)
Total fixed charges 2,086 2,837 2,820 3,769 3,880 5,123
Earnings available for fixed $(10,926) $9,744 $(10,927) $9,744 $(10,671) $10,085
charges
Ratio of earnings to fixed (5.24x) 3.44x (3.87x) 2.59x (2.75x) 1.97x
charges
- ----------------------------------- ------------ ------------ ------------ ---------- ------------ -----------
- -------------------------
- -------------------------------------------------------------------------------
(1) Presentation One assumes the exchange of $47,059,000 in principal amount of
old junior subordinated debentures for $10,237,500 in cash and $27,559,000
in principal amount of new 9% senior subordinated debentures.
(2) Presentation Two assumes the exchange of $47,059,000 in principal amount of
old junior subordinated debentures for $5,250,000 in cash and $37,059,000
in principal amount of new 9% senior subordinated debentures.
(3) Presentation Three assumes the exchange of $47,059,000 in principal amount
of old junior subordinated debentures for $47,059,000 in principal amount
of new 9% senior subordinated debentures.
(4) The representative interest portion of rental expense was deemed to be
one-third of all rental expense.
Proforma earnings were not sufficient to cover fixed charges during the first
nine months of 2000 by $13,012,000 for presentation one, $13,747,000 for
presentation two and $14,551,000 for presentation three; all other periods had
sufficient income to cover charges.
RISK FACTORS
By exchanging your old junior subordinated debentures for the exchange
consideration, you may be choosing to invest in the new senior subordinated
debentures. If you do not participate in the exchange offer, you will continue
to hold old junior subordinated debentures. An investment in our debentures
involves a high degree of risk. In addition to the other information contained
in or incorporated by reference into this prospectus, you should carefully
consider the following risk factors in deciding whether to tender your old
junior subordinated debentures in the exchange offer and what form of
consideration to request.
Risks relating to CII Financial
We may not be able to repay the principal amount of our debentures at their
maturity date.
CII Financial, as a holding company and sole obligor of the old junior
subordinated debentures, has no available source of cash with which to pay the
old junior subordinated debentures when they mature on September 15, 2001. Our
ability to service our indebtedness following the exchange offer, including our
payment obligations under the new senior subordinated debentures and any old
junior subordinated debentures that remain outstanding, and to meet our other
financial obligations, will depend upon our future operating performance, which
in turn is subject to market conditions and other factors, including factors
beyond our control. CII Financial, as a holding company, does not currently
generate cash flows that will be sufficient to pay the principal amount of the
debentures on their stated maturity dates. Our ability to repay the debentures
or to refinance our debentures will depend on the availability of new sources of
funding, which will in turn depend on our operating performance, the state of
the financial markets and other factors at the time that we want to repay or
refinance the debentures. Accordingly, we may not have the cash resources
required to meet our obligations to repay the old junior subordinated or new
senior subordinated debentures when they become due.
We may not be able to service our debt because of our operational structure.
Substantially all our assets consist of investments in our subsidiaries,
and our operations are currently conducted through our subsidiaries. Our
subsidiaries are separate and distinct legal entities and have no obligation,
contingent or otherwise, to pay any amounts due pursuant to the debentures,
whether by dividends, loans or other payments. In addition, the payment of
dividends and the making of loan advances to us by our subsidiaries are and will
continue to be subject to statutory and regulatory restrictions. California
Indemnity Insurance Company, which is our only direct subsidiary, cannot
currently pay any dividends to us without the prior approval of the California
Department of Insurance. If our subsidiaries cannot or do not distribute a
portion of their earnings to us or if their earnings are insufficient, we may be
unable to service our debt.
If we are required to perform on our guaranty of Sierra's credit facility, we
may not have enough assets to pay interest on or the principal amount of your
debentures.
In August 2000, CII Financial, but not any of our subsidiaries, became a
guarantor of Sierra's revolving credit facility. At December 31, 2000 the
credit
facility was fully drawn and had an outstanding balance of $135 million. On
December 15, 2000, Sierra amended and restated its credit facility. Prior to
this amendment, Sierra was in breach of the credit facility's financial
covenants. The old junior subordinated debentures and the new senior
subordinated debentures are subordinated to our guaranty of the credit facility
debt. In the event of a default in payment on our old junior subordinated
debentures, Sierra's senior lenders would have the right to receive payment in
full by us on our guaranty of Sierra's credit facility prior to any payment
being made on the old junior subordinated debentures or the new senior
subordinated debentures. In addition, in the event of Sierra's liquidation or
insolvency or payment default with respect to its credit facility, our assets
will be available to pay obligations on the debentures only after the credit
facility has been paid in full. As a result, if we are required to perform on
the guaranty we may not be able to pay the interest and principal of the
debentures.
After the exchange offer, we will have up to $182 million of senior indebtedness
that has and could continue to restrict our ability to obtain financing and
pursue various business opportunities.
CII Financial, as a holding company, has a significant amount of
outstanding indebtedness. Upon consummation of the exchange offer, we will have
up to $182,059,000 of senior indebtedness, consisting of the new senior
subordinated debentures, the credit facility guaranty and the demand promissory
note held by an affiliate. As a result, we will remain highly leveraged
following the exchange offer. This high leverage will restrict our flexibility
to obtain financing and pursue various business opportunities which could impact
our ability to pay the interest and principal of the debentures.
Since our business is concentrated geographically and by industry, adverse
changes in these areas could significantly impact our written premiums and
profitability.
Our current business is concentrated geographically and by industry. For
the nine months ended September 30, 2000, approximately 77% of our direct
written premiums were in California, 8% were in Colorado and 7% were in Nevada.
Policyholders whose primary business is construction account for approximately
32% of our premiums. Any adverse change in the economic condition of these areas
or in the construction industry that significantly affects our written premiums
could impair our ability to pay the interest and principal of the debentures.
If we are required to increase reserves for losses for adverse loss development
on prior accident years our subsidiaries will have less earnings available to
pay dividends to us, which will affect our ability to pay the interest and
principal of the debentures.
In both 1999 and 2000 we were required to increase reserves for losses
incurred in prior accident years. For the year ended December 31, 1999, we
increased reserves related to losses on prior accident years by a net amount of
$9.9 million. For the nine months ended September 30, 2000, we increased
reserves related to losses on prior accident years by a net amount of $20.2
million. A significant portion of this adverse loss development was related to
the 1996 through 1998 accident years and was primarily attributable to increased
severity of claims in California.
The average cost per claim under our workers' compensation policies has
increased each year since 1995. Two of the factors increasing the costs of
claims are medical inflation and, in California, adverse court decisions related
to medical control of claims.
If we are required to make additional increases in our loss reserves for
prior year incurred losses or if any such losses have a material impact on our
results of operations, our subsidiaries will have less earnings available to pay
dividends to us which will make it more difficult for us to pay the interest and
principal of the debentures.
If our reinsurers do not perform their obligations, we would experience
significant losses which could adversely affect our ability to pay the interest
and principal of the debentures.
In the ordinary course of our business we reinsure our losses with several
reinsurers. Reinsurance does not, however, relieve us of our obligation to
policyholders. As of September 30, 2000, we had over $211 million of reinsurance
receivables from our reinsurers. A single reinsurer accounts for approximately
87.6% of this amount. If these reinsurance companies fail to reimburse us for
losses paid by us under the direct policies, we would experience significant
losses which could adversely affect our ability to pay the interest and
principal of the debentures.
We have reduced our reinsurance coverage, which will expose us to greater risk
of ultimate loss.
For policies issued after June 30, 2000, our reinsurance coverage has a
much higher retention of liability, and covers claims in excess of $250,000 per
occurrence, compared to our former retention that had a maximum of $17,000 per
occurrence. As a result, we must pay a substantially higher portion of each
claim before we have recourse to our reinsurers. In making this change, we
expect an increase in premiums retained after reinsurance, an increase in
investment income over time and an increase in our net loss ratio. If our net
loss ratio increases greater than the offsetting investment income, then our
subsidiaries will have less earnings available to pay dividends to us, which
will affect our ability to pay the interest and principal of the debentures.
If the competitive environment in California continues to adversely affect our
premiums on workers' compensation insurance policies, our profitability and
ability to repay the debentures will be adversely affected.
For the nine months ended September 30, 2000, approximately 77% of our
direct written premiums were in California. There has been intense price
competition in California since that state replaced its minimum rate law with an
open rating premium law in 1995. While workers' compensation rates have risen in
California during 2000, the premiums charged remain lower than those charged
prior to the 1995 change in law. This price competition has affected and could
continue to affect our profitability. Many of our competitors are larger and
have significantly greater resources than us. Continued price competition could
reduce our profitability and may reduce the earnings of our subsidiaries
available to pay the interest and principal of the debentures.
If the open rating environment in Nevada scheduled for July 1, 2001 results in
price competition that requires us to lower our premiums, our profitability may
be harmed.
For the nine months ended September 30, 2000, approximately 7% of our
direct written premiums were in Nevada. Nevada is scheduled to change to an open
rating environment from a minimum rating environment beginning July 1, 2001.
After the introduction of open rating in California, premium rates were reduced.
As a result, premium revenues and operating profits were adversely affected due
to increased price competition and the risk of incurring losses. Although we
intend to underwrite each account taking into consideration the insured's risk
profile, prior loss experience, loss prevention plans and other underwriting
considerations, if the open rating environment in Nevada results in reduced
premiums, our profitability could be harmed and we may not have sufficient
subsidiary earnings to pay the interest and principal of the debentures.
A rating downgrade from insurance rating agencies could reflect negatively on
our reliability and make it more difficult for us to sell our workers'
compensation insurance policies.
In the event we default on our debentures, our subsidiaries' insurance
ratings may be downgraded. A downgrade of our insurance subsidiaries' rating by
A.M. Best or Fitch could adversely affect our sales of workers' compensation
insurance to customers since these customers frequently consider insurance
agency ratings as a factor in selecting their insurers.
If our costs are increased because of regulations and regulatory development we
may not be able to operate profitably.
Our insurance subsidiaries are subject to extensive regulation by the
California and Texas Departments of Insurance, and are also subject to
regulation in each additional jurisdiction in which they become licensed to
transact business. Because insurance regulations are designed primarily for the
protection of policyholders rather than stockholders or creditors, these
regulations could impede our creditors' ability to fully enforce their rights.
Our failure to comply with these regulations could result in various regulatory
actions including oversight of our insurance subsidiaries or other actions which
could adversely affect our operations and our ability to service our debt. The
nature and extent of such regulations varies from jurisdiction to jurisdiction,
but typically involves:
o standards of solvency and minimum amounts of capital and surplus which
must be maintained;
o limits on types and amounts of investments;
o restrictions on the size of risks which may be insured by a single
company;
o licensing of insurers and their agents;
o required deposits of securities for the benefit of policyholders;
o approval of policy forms;
o establishment of statutory reporting practices and the form and content
of statutory financial statements;
o establishment of methods for setting statutory loss and expense reserves;
o review, and in some instances, prior approval of premium rates;
o limits on transactions among insurers and their affiliates;
o approval of all proposed changes of control;
o approval of dividends;
o setting and collecting guarantee fund assessments; and
o required filing of annual and other reports with respect to the
financial condition and operation of insurers. In addition, state
regulatory examiners perform periodic financial and underwriting
examinations of insurers.
Changes in regulation could further increase our costs. For example, the
National Association of Insurance Commissioners, or the NAIC, which is a
voluntary organization of state regulators, is currently engaged in a project to
codify statutory accounting practices. This project is likely to change the
definition of what constitutes prescribed versus permitted statutory accounting
practices and may result in changes to the accounting policies that insurance
enterprises use to prepare their statutory financial statements. If our costs
are increased or if the operations of our insurance subsidiaries are otherwise
adversely affected by insurance regulations, our profitability could be harmed
and we may not have sufficient subsidiary earnings to pay the interest and
principal of the debentures.
If we are unable to maintain and improve our management information system, our
operations would be adversely affected.
Our management information system is critical to our current and future
operations. The information gathered and processed by our management information
system assists us in, among other things, pricing our product, invoicing and
collecting our premiums, processing and paying our claims and vendor invoices
and providing us with information to manage our business. In the past we have
encountered some difficulty with replacing or enhancing our systems. In 1998 we
began a two-year project to convert our policy and claims processing system from
our internally developed software to software supported by a third party vendor.
The conversion failed due to non-performance by the vendor. Our internally
developed software, which is critical to our operations, runs on WANG hardware.
Although WANG has continued to support the hardware, there is uncertainty of
future availability and cost of hardware upgrades. If our systems were to fail
or if we were unable to expand or enhance the capability of our systems, our
business would be adversely affected. We are planning to migrate our claims and
policy processing functions off the WANG platform and on to a Hewlett Packard /
Unix based operating system.
Power interruptions due to power shortages in California will negatively impact
our operations.
Our centralized WANG computer system is housed in Northern California
and has recently been shut down for a short period of time due to a power
outage. Our WANG system is supported by an uninterrupted power source, which
provides up to ninety minutes of power during a power outage. The uninterrupted
power source requires twelve hours to recharge after each use. We are currently
in the process of upgrading our uninterrupted power source to allow operation of
the WANG system without interruption for approximately three hours and to
provide a portion of our desktop units with power during this period. In the
event a power outage occurs which lasts longer,we may experience data corruption
with respect to the claims and policy information being used at the time the
system shuts down. In addition, our employees in all states would be prevented
from accessing the claims and policy processing systems during a prolonged power
outage. We are in the planning stages to move the centralized computer system
outside the state of California.
Approximately half of our employees are located in California. A power
outage not only reduces the productivity of these employees but also impacts our
ability to service our customers. Should the frequency or duration of the power
outages increase, our business would be adversely impacted.
Factors beyond our control may lead to reduced premium levels and investment
income which could make it more difficult for us to repay the debentures.
In the workers' compensation insurance business, changes in economic
conditions can lead to reduced premium levels due to lower payrolls and to
increased claims due to the tendency of workers who are laid off to submit
workers' compensation claims. Changes in market interest rates can affect the
amount of interest income that we can earn on our investment portfolio, as well
as the amount of realized and unrealized gains or losses on specific holdings
within our investment portfolio. Any reduction in premium levels or in the
interest income we earn on our investment portfolio could adversely affect our
business and ability to repay the debentures.
We are controlled by Sierra and since Sierra's interests may not be the same as
the interests of the holders of the debentures, Sierra's actions could adversely
affect our ability to pay the interest and principal of the new debentures.
All of CII Financial's common stock is owned by Sierra. Sierra thus is able
to elect our board of directors and thereby indirectly control our policies and
those of our subsidiaries, including mergers, sales of assets and similar
transactions. Shares of our common stock and shares of common stock of our
subsidiaries may from time to time be pledged, subject to certain regulatory
requirements, to secure obligations of Sierra or its affiliates. CII Financial
has guaranteed Sierra's obligations under its fully drawn $135 million senior
secured credit facility. Since the interests of Sierra may not be the same as
the interests of the holders of debentures, Sierra's actions could adversely
affect our ability to pay the interest and principal of the debentures.
Risks relating to our debentures
We expect a limited trading market for the debentures and this will make it
difficult for you to sell them.
The old junior subordinated debentures are not listed on any securities
exchange or quoted on The Nasdaq Stock Market. Although we have applied to list
the new senior subordinated debentures on the New York Stock Exchange, we do not
expect any active trading market for our debentures to exist. Accordingly, you
may have difficulty selling your debentures after the expiration of the offer.
To the extent that the old junior subordinated debentures are tendered and
accepted in the exchange offer, the outstanding principal amount available for
trading will be reduced, and consequently, any existing trading market for the
remaining old junior subordinated debentures will likely become even more
limited than it is now. As a result, you may have even more difficulty selling
your old junior subordinated debentures after the consummation of the exchange
offer.
Since the old junior subordinated debentures will rank junior to the new
senior subordinated debentures, in the event of a default, we will only be able
to make payments to holders of old junior subordinated debentures after the
guaranty of Sierra's credit facility, new senior subordinated debentures and any
other senior debt has been paid in full.
The old junior subordinated debentures will rank junior to the new senior
subordinated debentures and to our guaranty of Sierra's credit facility and
other senior debt. The risk of non-payment to holders of old junior subordinated
debentures will be increased because, in the event of a payment default, we will
only be able to make payments to holders of old junior subordinated debentures
after the new senior subordinated debentures, the guaranty of Sierra's credit
facility and any other senior debt has been paid in full.
Risks Associated with the Exchange Offer
If the cash option is oversubscribed, you will have to accept new senior
subordinated debentures as part of your exchange consideration.
If you elect to receive cash in the exchange offer, and the cash option is
oversubscribed, you will receive new senior subordinated debentures as a portion
of your exchange consideration. We will not determine whether the cash option
for the exchange consideration has been oversubscribed until after the
expiration of the exchange offer. You will not be able to withdraw your tender
of old junior subordinated debentures at the time we make this determination
even though it may affect the type of exchange consideration you will receive in
the exchange offer.
The exchange offer may not represent a fair valuation of the old junior
subordinated debentures and holders who do not tender their old junior
subordinated debentures may receive less than we are offering when the old
junior subordinated debentures mature.
Our board of directors has made no determination that the exchange offer
represents a fair valuation of the old junior subordinated debentures. We have
not obtained a fairness opinion from any financial advisor about the fairness of
the exchange offer to you or us. We do not now have an available source of cash
with which to pay the old junior subordinated debentures when they mature on
September 15, 2001. If we default on the old junior subordinated debentures, up
to $182 million of indebtedness that ranks senior to those debentures could
come due and would then have to be paid first. In that event, our
remaining cash resources may not be sufficient to pay the old junior
subordinated debentures. In fact, the amount then available to pay these
debentures may be less than the cash available under this exchange offer.
If we are unable to fund the cash portion of the exchange consideration, we will
not be able to complete the exchange offer.
We intend to fund the cash portion of the exchange consideration through a
combination of dividends or other transfers from our California insurance
subsidiaries and a loan from an affiliate. The insurance subsidiaries may not be
permitted to declare and pay dividends or make other transfers to us unless the
California Department of Insurance approves. We may not receive this regulatory
approval. Our affiliates are under no obligation to loan funds to us. If we are
unable to obtain the cash required for this transaction, we will not be able to
complete the exchange offer.
If Sierra does not receive the consent of Sierra's lenders under its $135
million credit facility to the exchange offer, we will not be able to complete
the exchange offer.
The consent of the lenders under Sierra's credit facility is required in
order for us to consummate the exchange offer. Sierra may not receive the
lenders' consent if the lenders disapprove of the terms of the exchange offer.
If the consent is not received, we will not be able to complete the exchange
offer.
If the proposed exchange offer is unsuccessful and we are required to perform on
our credit facility guaranty and are forced to sell our insurance
subsidiaries, the amount of
cash available to pay the old junior subordinated debentures would likely be
less than the cash available under this exchange offer.
If the proposed exchange offer is unsuccessful and we were to default on
the payment of the old junior subordinated debentures when they mature, then
there will be a cross default on Sierra's credit facility debt and the banks may
demand that CII Financial perform on its payment guaranty. If we then had to
sell our insurance subsidiaries, our net cash proceeds would probably be
substantially less than if the sale were to occur when we were not in a default
situation. Under such circumstances, the California Department of Insurance
could, among other things, exercise its oversight powers to preserve the assets
of the insurance companies for the benefit of the policyholders and claimants
and could prevent or significantly delay a possible sale of our insurance
subsidiaries. If we are required to perform on the credit facility guaranty
and are forced to
sell our insurance subsidiaires, the amount of cash available to pay the old
junior subordinated debentures would likely be less than the cash available
under this exchange offer.
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
We have made forward-looking statements with respect to our financial
condition, results of operations and business and on the expected impact of the
exchange offer on our financial performance. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates" and similar
expressions identify forward-looking statements. These forward-looking
statements are not guarantees of future performance and are subject to risks and
uncertainties, including those described under "Risk Factors" in this
prospectus, that could cause actual results to differ materially from the
results contemplated by the forward-looking statements.
In evaluating the exchange offer, you should carefully consider the
discussion of risks and uncertainties in the section entitled "Risk Factors" on
page 12 of this prospectus.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed a registration statement on Form S-4 under which we are
registering the new senior subordinated debentures to be issued to our debenture
holders in the exchange offer. This prospectus is a part of that registration
statement.
This prospectus does not contain all of the information in the registration
statement and the exhibits and schedules to it. For further information with
respect to us and our new senior subordinated debentures, we refer you to the
registration statement and to the exhibits and schedules to the registration
statement. Statements contained in this prospectus as to the contents of any
contract or any other document referred to are not necessarily complete, and in
each instance, we refer you to the copy of the contract or other document filed
as an exhibit to the registration statement. Each of these statements is
qualified in all respects by this reference.
You may inspect copies of the registration statements without charge at the
SEC's principal office in Washington, D.C., and copies of all or any part of the
registration statement may be obtained from the Public Reference Section of the
SEC, 450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of fees
prescribed by the SEC.
We do not currently file reports and information with the SEC. Upon
completion of this offering, we will be subject to the information reporting
requirements of the Securities Exchange Act of 1934 and we will file reports,
and other information with the SEC.
You may read and copy any reports, statements or other information that we
file with the SEC at the SEC's public reference rooms at the following
locations:
Public Reference Room New York Regional Office Chicago Regional Office
450 Fifth Street, N.W. 7 World Trade Center Citicorp Center
Room 1024 Suite 1300 500 West Madison Street
Washington, D.C. 20549 New York, NY 10048 Suite 1400
Chicago, IL 60661-2511
Please call the SEC at 1-800-SEC-0330 for further information on the public
reference rooms. These SEC filings are also available to the public from
commercial document retrieval services and at the Internet worldwide web site
maintained by the SEC at "http://www.sec.gov". Reports, proxy statements and
other information concerning Sierra may also be inspected at the offices of the
New York Stock Exchange, which is located at 20 Broad Street, New York, New York
10005.
The old junior subordinated debentures are convertible into shares of
Sierra common stock. Sierra has filed a registration statement on Form S-3 under
which it registered the shares of Sierra common stock into which the old junior
subordinated debentures are convertible. In addition, Sierra files annual,
quarterly and special reports and other information with the SEC. Documents
filed by Sierra with the SEC can be obtained as described above. The
registration statement and Sierra's periodic filings under the Exchange Act are
not incorporated by reference in this prospectus.
- -----------------------------------
USE OF PROCEEDS
The new senior subordinated debentures issued in connection with the
exchange offer are only being issued in exchange for your old junior
subordinated debentures. We will not receive any cash proceeds from the issuance
of new senior subordinated debentures pursuant to the exchange offer. All old
junior subordinated debentures accepted by us in the exchange offer will be
canceled.
CAPITALIZATION
The following table sets forth as of September 30, 2000:
o our actual capitalization; and
o our capitalization adjusted to reflect the tender of all $47,059,000
aggregate principal amount of old junior subordinated debentures in the exchange
offer and full subscription of the cash option, so that owners tendering
outstanding old junior subordinated debentures will receive, in the aggregate,
$10,237,500 in cash and $27,559,000 principal amount of new senior subordinated
debentures under the exchange offer.
We intend to fund a portion of the cash consideration of the exchange
offer, as well as interest and expenses, through a loan from an affiliate
evidenced by a demand promissory note, which we refer to as the affiliate note.
The amount of this loan will be determined prior to the expiration of the
exchange offer. For purposes of this table, we have assumed that the amount of
the affiliate note will be $5.0 million.
To the extent that old junior subordinated debentures are not validly
tendered or accepted in the exchange offer, the amount set out below in the "pro
forma" column for the new senior subordinated debentures and the affiliate note,
depending on the election of the debenture holder, may decrease and the amount
set out below in the "pro forma" column for the old junior subordinated
debentures would increase. In addition, it is possible that the cash option will
not be fully subscribed. In that event, the amount set below in the "pro forma"
column for the new senior subordinated debentures would increase and the amount
of the affiliate note may decrease. This information should be read in
conjunction with our consolidated financial statements and notes thereto which
are included elsewhere in this prospectus.
September 30, 2000
Historical Adjustment Proforma
(dollars in thousands, except share data)
Total debt:
New senior subordinated debentures (1)............. - $36,821 $36,821
Old junior subordinated debentures (2)............. $ 47,059 (47,059) -
Notes payable-affiliates (3)....................... - 5,000 5,000
Other debt......................................... - _ -
------------ ---------------
Total debt....................................... 47,059 (5,238) 41,821
Stockholder's equity:
Common stock, no par value; 1,000 shares authorized;
100 shares issued and outstanding 3,604 3,604
- --------------------------------------------------------- 64,450 64,450
Additional paid-in capital.........................
Accumulated other comprehensive loss:
Unrealized holding loss on available-for-sale
investments ................................... (8,651) (8,651)
Accumulated deficit ................................. (889) (889)
---------- ------------
Total stockholder's equity....................... 58,514 58,514
---------- -----------
Total capitalization............................. $105,573 $(5,238) $100,335
(1) New senior subordinated debentures will have an accounting book value of
$36,821,000, which includes a deferred gain of $9,262,500. This premium will
be amortized over the life of the senior subordinated debentures.
- -------------------------------------------------------------------------------
(2) Retirement of old junior subordinated debentures for new senior
subordinated debentures and cash.
(3) New affiliate note payable.
THE EXCHANGE OFFER
This section of the prospectus describes the proposed exchange offer. While
we believe that the description covers the material terms of the exchange offer,
this summary may not contain all of the information that is important to you.
You should read this entire document and the other documents we refer to
carefully for a more complete understanding of the exchange offer.
Terms of the Exchange Offer
Upon the terms and subject to the conditions of the exchange offer set
forth in this prospectus and in the accompanying letter of transmittal, you can
choose to exchange your old junior subordinated debentures for:
o $1,000 in principal amount of new senior subordinated debentures for
each $1,000 in principal amount of
old junior subordinated debentures that you tender; or
o $525 in cash for each $1,000 in principal amount of the old junior
subordinated debentures that you tender, up to a maximum of
$19,500,000 aggregate principal amount of old junior subordinated
debentures as described below.
We will pay in cash accrued and unpaid interest on all old junior
subordinated debentures accepted in the exchange offer to, but not including,
the date of acceptance.
We have structured the exchange offer based on what we believe is an
attractive offer to holders based on historical trading prices for the old
junior subordinated debentures, the financial condition of our business, and our
ability to pay the interest and principal on the old junior subordinated
debentures when due.
We are only offering to purchase a maximum of $19,500,000 aggregate
principal amount of old junior subordinated debentures for cash. If holders of
more than $19,500,000 aggregate principal amount of old junior subordinated
debentures elect the cash option, we will not have enough cash to pay for all
the debentures that holders elect to sell. In that case, we will purchase a
total of $19,500,000 principal amount of old junior subordinated debentures for
cash and we will exchange the balance of the old junior subordinated debentures
we receive for new senior subordinated debentures. All holders who elect the
cash option will be permitted to sell the same fraction of their old junior
subordinated debentures for cash. This fraction will equal $19,500,000, divided
by the aggregate principal amount of all debentures tendered for cash by all
holders. To receive the maximum amount of cash, you must tender all of your old
junior subordinated debentures for the cash option.
The following table illustrates how new senior subordinated debentures and
cash will be distributed in the aggregate under three scenarios, all of which
assume that 100% of the old junior subordinated debentures are tendered, but
each of which assumes that a different percentage of holders elects the cash
option. The three scenarios are: first, that no old junior subordinated
debentures are tendered for cash; second, that $19,500,000 of old junior
subordinated debentures are tendered for cash; and third, that $47,059,000 of
old junior subordinated debentures are tendered for cash.
Principal amount of Cash paid for old Principal amount of new
old junior junior subordinated senior subordinated
subordinated debentures debentures issued for
debentures tendered old junior subordinated
for cash debentures
----------------------- ----------------------- --------------------------
$ 0 $ 0 $47,059,000
$19,500,000 $10,237,500 $27,559,000
$47,059,000 $10,237,500 $27,559,000
We will not determine whether the cash option has been oversubscribed until
after the expiration of the exchange offer. You will not be able to withdraw
your tender of old junior subordinated debentures once we make this
determination even though it may affect the type of exchange consideration you
will receive in the exchange offer. We will publicly announce whether the cash
option has been oversubscribed and the effect of any required proration of
exchange consideration as soon as practicable after the expiration of the
exchange offer.
You do not have to choose the same option for all of the old junior
subordinated debentures that you tender. You do not have to tender all of your
old junior subordinated debentures to participate in the exchange offer. You may
withdraw your tender of old junior subordinated debentures at any time before
the expiration of the exchange offer.
Our board of directors makes no recommendation to owners of the old junior
subordinated debentures whether or not to tender their debentures in the
exchange offer or as to the form of exchange consideration to elect. In
addition, we have not authorized anyone to make a recommendation on our behalf
regarding the exchange offer. Owners of the old junior subordinated debentures
must make their own decision whether to tender their old junior subordinated
debentures in the exchange offer and as to the form of exchange consideration to
elect.
Principal Differences between the Old Junior Subordinated Debentures and the
New Senior Subordinated Debentures
The terms of our old junior subordinated debentures and our new senior
subordinated debentures are described in more detail in the sections headed
"Description of Debentures." The principal differences are as follows:
o The new senior subordinated debentures will rank senior in right of
payment to any old junior subordinated debentures which are not
tendered.
o You will receive a higher rate of interest on the new senior
subordinated debentures, which will pay 9% per annum, than on the old
junior subordinated debentures, which pay 7 1/2% per annum.
o The scheduled maturity date of the new senior subordinated debentures
is September 15, 2006, which is five years later than September 15,
2001, the scheduled maturity date of the old junior subordinated
debentures.
o The new senior subordinated debentures will not be convertible into
Sierra common stock. The old junior subordinated debentures are
convertible into Sierra common stock at $39.398 per share.
Period For Tendering Your Debentures
Subject to applicable securities laws and the terms and conditions in this
prospectus, we will accept for exchange any and all old junior subordinated
debentures that are validly tendered and not withdrawn before 5:00 p.m., New
York City time, on the expiration date of the exchange offer.
If we make a material change in the terms of the exchange offer or the
information concerning the exchange offer or waive a material condition to the
exchange offer, we will disseminate additional exchange offer materials and
extend the exchange offer to the extent required by law. In addition, we may, if
we deem appropriate, extend the exchange offer for any other reason. If the
consideration to be paid in the exchange offer is increased or decreased or the
principal amount of old junior subordinated debentures subject to the exchange
offer is decreased, the exchange offer will remain open at least 10 business
days from the date we first give notice to you, by public announcement or
otherwise, of that increase or decrease. In the case of an extension of the
exchange offer, the announcement will be issued no later than 9:00 a.m., New
York time, on the next business day after the previously scheduled expiration of
the exchange offer. Without limiting the manner in which any public announcement
may be made, we will have no obligation to publish, advertise or otherwise
communicate any public announcement other than by issuing a release to the Dow
Jones News Service.
Market and Trading Information Regarding the Old Junior Subordinated Debentures
The old junior subordinated debentures currently are traded
over-the-counter. There is no established reporting system or trading market for
trading in the old junior subordinated debentures. Accordingly, there is no
practical way to determine the trading history of the old junior subordinated
debentures. We believe that trading in the old junior subordinated debentures
has been limited and sporadic. We believe that the trading market for the old
junior subordinated debentures that remain outstanding after the exchange offer
will be very limited.
Acceptance for Exchange of Debentures
Upon the terms and subject to the conditions of the exchange offer and
applicable law, we will exchange the applicable exchange consideration for all
old junior subordinated debentures validly tendered and not withdrawn under the
exchange offer on or prior to the expiration of the exchange offer.
This exchange will be made by our deposit of the exchange consideration
with the exchange agent as soon as practicable after the expiration of the
exchange offer so that the exchange consideration may be paid to you on the
exchange date.
The exchange agent will act as agent for you for the purpose of issuing the
exchange consideration for the old junior subordinated debentures. Under no
circumstances will interest on the exchange consideration be paid by us by
reason of any delay on behalf of the exchange agent in making that exchange.
We expressly reserve the right, in our sole discretion and subject to Rule
14e-l(c) under the Exchange Act of 1934, to delay acceptance for exchange of, or
the exchange of, old junior subordinated debentures in order to comply, in whole
or in part, with any applicable law or regulation.
In all cases, the exchange agent will deliver the exchange consideration
for old junior subordinated debentures accepted for exchange under the exchange
offer only after timely receipt by the exchange agent of:
o certificates representing your old junior subordinated debentures or
timely confirmation of a book-entry transfer of your old junior
subordinated debentures into the exchange agent's account at DTC;
o a properly completed and duly executed letter of transmittal, or a
manually signed facsimile thereof or,
in the case of book-entry transfer, an "agent's message"; and
o any other documents required by the letter of transmittal.
For purposes of the exchange offer, validly tendered old junior
subordinated debentures, or defectively tendered old junior subordinated
debentures for which we have waived that defect, will be deemed to have been
accepted for exchange by us if, as and when we give written notice thereof to
the exchange agent.
If the exchange offer is terminated or withdrawn, or the old junior
subordinated debentures are not accepted for exchange, no exchange consideration
will be paid or payable. If any tendered old junior subordinated debentures are
not exchanged under the exchange offer for any reason, or certificates are
submitted evidencing more old junior subordinated debentures than are tendered,
those old junior subordinated debentures not exchanged will be returned, without
expense, to you, or, in the case of old junior subordinated debentures tendered
by book-entry transfer, those old junior subordinated debentures will be
credited to the account maintained at DTC from which those old junior
subordinated debentures were delivered, unless otherwise requested by you under
the heading "Special Delivery Instructions" in the letter of transmittal,
promptly after the expiration of the exchange offer or termination of the
exchange offer.
Procedures for Exchanging Debentures
In order to receive the exchange consideration you must tender your old
junior subordinated debentures under the exchange offer on or before its
expiration.
The method of delivery of old junior subordinated debentures and letters of
transmittal, any required signature guarantees and all other required documents,
including delivery through DTC and any acceptance of an agent's message
transmitted through ATOP, is at your election and risk. Except as otherwise
provided in the letter of transmittal, delivery will be deemed made only when
actually received by the exchange agent. If delivery is by mail, we suggest that
you use properly insured, registered mail with return receipt requested, and
that the mailing be made sufficiently in advance of the expiration of the
exchange offer.
It is contemplated that our new senior subordinated debentures will be
delivered in book-entry form through DTC. Accordingly, if you anticipate
tendering other than through DTC, you are urged to promptly contact a bank,
broker or other intermediary that has the capability to hold securities
custodially through DTC, to arrange for the receipt of any new senior
subordinated debentures to be delivered as part of the exchange consideration,
and to obtain the information necessary in the letter of transmittal. The
payment of any cash to you will be paid to you by the exchange agent.
If you have any questions or need help in tendering your notes, please call
the information agent whose address and phone number are on the back cover of
this prospectus.
Tenders of debentures. Your tender of old junior subordinated debentures,
and subsequent acceptance by us, by one of the procedures set out below will
constitute a binding agreement between us and you in accordance with the terms
and subject to the conditions set forth in this prospectus, in the letter of
transmittal and, if applicable, in the notice of guaranteed delivery.
Tenders of debentures held in physical form. To effectively tender old
junior subordinated debentures held in physical form:
o you must properly complete and duly execute a letter of transmittal,
or a manually signed facsimile thereof, and any other documents
required by the letter of transmittal, and those documents must be
received by the exchange agent at its address set out on the back
cover of this prospectus; and
o you must ensure that certificates representing those old junior
subordinated debentures are received by the exchange agent at that
address on or prior to the expiration of the exchange offer.
Letters of transmittal and old junior subordinated debentures should be
sent only to the exchange agent and should not be sent to us, the information
agent or the dealer manager.
If your old junior subordinated debentures are registered in the name of a
person other than the signatory to the letter of transmittal, then, in order to
tender those old junior subordinated debentures under the exchange offer, the
old junior subordinated debentures must be endorsed or accompanied by an
appropriate written instrument or instruments of transfer signed exactly as that
name appears on the old junior subordinated debentures, with the signature on
the old junior subordinated debentures or instruments of transfer guaranteed as
provided below.
Tender of debentures held through a custodian. If your old junior
subordinated debentures are registered in the name of a broker, dealer,
commercial bank, trust company or other nominee and if you wish to tender old
junior subordinated debentures and deliver a letter of transmittal, you should
contact that broker, dealer, commercial bank, trust company or other nominee
promptly and instruct him or her or it to tender old junior subordinated
debentures and deliver a letter of transmittal on your behalf. A letter of
instructions is enclosed in the materials provided along with this prospectus
which may be used by you in this process to instruct the registered holder to
tender old junior subordinated debentures. If you wish to tender those old
junior subordinated debentures yourself, you must, prior to completing and
executing the letter of transmittal and delivering those old junior subordinated
debentures, either make appropriate arrangements to register ownership of the
old junior subordinated debentures in your name or follow the procedures
described in the immediately preceding paragraph. The transfer of record
ownership may take considerable time.
Tender of debentures held through DTC. We have confirmed with DTC that the
old junior subordinated debentures may be tendered using ATOP. DTC participants
may electronically transmit their acceptance of the exchange offer by causing
DTC to transfer their old junior subordinated debentures to the exchange agent
using the ATOP procedures. In connection with the transfer, DTC will send an
"agent's message" to the exchange agent. The agent's message states that DTC has
received instructions from the participant to tender old junior subordinated
debentures and that the participant agrees to be bound by the terms of the
letter of transmittal.
By using the ATOP procedures to tender old junior subordinated debentures,
you will not be required to deliver a letter of transmittal to the exchange
agent. However, you will be bound by its terms just as if you had signed it.
Book-entry delivery procedures. The exchange agent will establish accounts
with respect to the old junior subordinated debentures at DTC for purposes of
the exchange offer within two business days after the date of this prospectus.
Although delivery of old junior subordinated debentures may be effected
through book-entry transfer into the exchange agent's account at DTC, the letter
of transmittal, or a manually signed facsimile thereof, with any required
signature guarantees, or an agent's message, in connection with a book-entry
transfer, and any other required documents, must, in any case, be transmitted,
to and received by the exchange agent at one or more of its addresses set out on
the back cover of this prospectus on or prior to the expiration of the exchange
offer in connection with the tender of those old junior subordinated debentures.
Delivery of documents to DTC does not constitute delivery to the exchange agent.
The confirmation of a book-entry transfer into the exchange agent's account
at DTC as described above is referred to in this prospectus as a "book-entry
confirmation." The term "agent's message" means a message transmitted by DTC to,
and received by, the exchange agent and forming a part of the book-entry
confirmation, which states that DTC has received an express acknowledgment from
a DTC participant that such participant has received the letter of transmittal
and agrees to be bound by the terms of the letter of transmittal.
Signature guarantees. Signatures on all letters of transmittal must be
guaranteed by a recognized participant in the Securities Transfer Agents
Medallion Program, unless your tender of old junior subordinated debentures
tendered are tendered:
o by a registered holder of old junior subordinated debentures, or by a
participant in DTC whose name appears on a security position listing
as the owner of those old junior subordinated debentures, who has not
completed any of the boxes entitled "Special Payment Instructions" or
"Special Delivery Instructions" on the letter of transmittal; or
o for the account of a member firm of a registered national securities
exchange, a member of the National Association of Securities Dealers,
Inc. or a commercial bank or trust company having an office or
correspondent in the United States, which entities we refer to as
"eligible institutions".
If your old junior subordinated debentures are registered in the name of a
person other than the signatory to the letter of transmittal or if old junior
subordinated debentures not accepted for exchange or not tendered are to be
returned to a person other than the registered holder, then the signature on the
letter of transmittal accompanying the tendered old junior subordinated
debentures must be guaranteed. See Instructions 1 and 5 of the letter of
transmittal.
Mutilated, lost, stolen or destroyed certificates. If you desire to tender
old junior subordinated debentures, but the certificates evidencing those old
junior subordinated debentures have been mutilated, lost, stolen or destroyed,
you should contact us for information about the procedures for obtaining
replacement certificates for old junior subordinated debentures at the following
address or telephone number: 2716 North Tenaya Way, Las Vegas, Nevada 89128 or
(702) 242-7040.
Guaranteed delivery. If you want to tender old junior subordinated
debentures under the exchange offer prior to the expiration of the exchange
offer and,
o your certificates representing those old junior subordinated debentures
are not immediately available;
o time will not permit your letter of transmittal, the certificates
representing your old junior subordinated debentures and all other
required documents to reach the exchange agent on or prior to the
expiration of the exchange offer; or
o the procedures for book-entry transfer, including delivery of an
agent's message, cannot be completed on or prior to the expiration of
the exchange offer, you may nevertheless tender your old junior
subordinated debentures with the effect that tender will be deemed to
have been received on or prior to the expiration of the exchange offer
if all the following conditions are satisfied:
o the tender is made by or through an eligible institution;
o a properly completed and duly executed notice of guaranteed delivery
or an agent's message with respect to guaranteed delivery that is
accepted by us is received by the exchange agent on or prior to the
expiration of the exchange offer as provided below; and
o the certificates for the tendered old junior subordinated debentures,
in proper form for transfer, or a book-entry confirmation of the
transfer of those old junior subordinated debentures into the exchange
agent's account at DTC as described above, together with a letter of
transmittal, or manually signed facsimile thereof, that is properly
completed and duly executed, with any signature guarantees and any
other documents required by the letter of transmittal, or a properly
transmitted agent's message, are received by the exchange agent within
two business days after the date of execution of the notice of
guaranteed delivery.
The notice of guaranteed delivery may be sent by hand delivery, facsimile
transmission or mail to the exchange agent and must include a guarantee by an
eligible institution in the form set out in the notice of guaranteed delivery.
Under no circumstances will interest be paid by us by reason of any delay
in exchanging old junior subordinated debentures for the exchange consideration
to any person using the guaranteed delivery procedures that results from this
guaranteed delivery. The exchange consideration for old junior subordinated
debentures tendered under the guaranteed delivery procedures will be the same as
for old junior subordinated debentures delivered to the exchange agent on or
prior to the expiration of the exchange offer, even if the old junior
subordinated debentures to be delivered subject to the guaranteed delivery
procedures are not so delivered to the exchange agent, and therefore exchange by
the exchange agent on account of those old junior subordinated debentures is not
made, until after the exchange date.
Backup United States federal income tax withholding. To prevent backup
federal income tax withholding you must provide the exchange agent with your
current taxpayer identification number and certify that you are not subject to
backup federal income tax withholding by completing the Substitute Form W-9
included in the letter of transmittal.
Determination of validity. All questions as to the validity, form,
eligibility, including time of receipt, and acceptance of any tendered old
junior subordinated debentures subject to any of the procedures described above
will be determined by us, in our sole discretion, which determination shall be
final and binding.
We reserve the right to reject any or all tenders of any old junior
subordinated debentures that we determine not to be in proper form or if the
acceptance for tender of those old junior subordinated debentures may, in the
opinion of our counsel, be unlawful. We also reserve the right to waive any of
the conditions of the exchange offer or any defect or irregularity in any tender
of your old junior subordinated debentures, whether or not similar defects or
irregularities are waived in the case of other holders of old junior
subordinated debentures.
Our interpretation of the terms and conditions of the exchange offer,
including the letter of transmittal and the instructions thereto, will be final
and binding. Neither we, the exchange agent nor any other person will be under
any duty to give notification of any defects or irregularities in tenders or
will incur any liability for failure to give any such notification. If we waive
our right to reject a defective tender of old junior subordinated debentures,
you will be entitled to the exchange consideration.
Withdrawal of Tendered Old Junior Subordinated Debentures
You may withdraw tenders of debentures at any time on or prior to the
expiration of the exchange offer, but the exchange consideration shall not be
payable in respect of old junior subordinated debentures so withdrawn. We will
not determine whether the cash option for the exchange consideration has been
oversubscribed until after the expiration of the exchange offer. You will not be
able to withdraw your tender of old junior subordinated debentures at the time
we make this determination even though it may affect the type of exchange
consideration you will receive in the exchange offer.
Tenders of old junior subordinated debentures may be validly withdrawn if
the exchange offer is terminated without any old junior subordinated debentures
being exchanged thereunder. In this case, the old junior subordinated debentures
tendered under the exchange offer will be promptly returned to you.
If we make a material change in the terms of the exchange offer or waive a
material condition of the exchange offer, we will disseminate additional
exchange offer materials and extend the exchange offer to the extent required by
law. In addition, we may, if we deem appropriate, extend the exchange offer for
any other reason. If the consideration to be paid in the exchange offer is
increased or decreased or the principal amount of old junior subordinated
debentures subject to the exchange offer is decreased, the exchange offer will
remain open at least 10 business days from the date we first give notice to you,
by public announcement or otherwise, of that increase or decrease.
For a withdrawal of tendered old junior subordinated debentures to be
effective, a written or facsimile transmission notice of withdrawal must be
received by the exchange agent on or prior to the expiration of the exchange
offer at its address set out on the back cover of this prospectus. Any such
notice of withdrawal must:
o specify the name of the person who tendered the old junior subordinated
debentures to be withdrawn;
o contain the description of the old junior subordinated debentures to
be withdrawn and identify the certificate number or numbers shown on
the particular certificates evidencing those old junior subordinated
debentures, unless those old junior subordinated debentures were
tendered by book-entry transfer, and the aggregate principal amount
represented by those old junior subordinated debentures; and
o be signed in the same manner as the original signature on the letter
of transmittal by which those old junior subordinated debentures were
tendered, including any required signature guarantees, or be
accompanied by evidence sufficient to the exchange agent that the
person withdrawing the tender has succeeded to the beneficial
ownership of the old junior subordinated debentures.
If the old junior subordinated debentures to be withdrawn have been
delivered or otherwise identified to the exchange agent, a signed notice of
withdrawal is effective immediately upon written or facsimile notice of that
withdrawal even if physical release is not yet effected.
Any permitted withdrawal of old junior subordinated debentures may not be
rescinded, and any old junior subordinated debentures properly withdrawn will
thereafter be deemed not validly tendered for purposes of the exchange offer.
Withdrawn old junior subordinated debentures may, however, be re-tendered by
again following one of the appropriate procedures described in this prospectus
at any time on or prior to the expiration of the exchange offer.
If we extend the exchange offer or if for any reason, whether before or
after any old junior subordinated debentures have been accepted for tender, the
acceptance for tender of old junior subordinated debentures is delayed or if we
are unable to accept the tender of old junior subordinated debentures under the
exchange offer, then, without prejudice to our rights under the exchange offer,
tendered old junior subordinated debentures may be retained by the exchange
agent on our behalf and may not be withdrawn, subject to Rule 14e-l(c) under the
Exchange Act, which requires that an offeror pay the consideration offered or
return the securities deposited by or on behalf of the investor promptly after
the termination or withdrawal of a tender offer, except as otherwise provided in
this section.
All questions as to the validity, form and eligibility, including time of
receipt, of notices of withdrawal will be determined by us, in our sole
discretion, which determination shall be final and binding. Neither we, the
exchange agent, the dealer manager, the information agent nor any other person
will be under any duty to give notification of any defects or irregularities in
any notice of withdrawal, or incur any liability for failure to give any such
notification.
Conditions to, and Amendment of, the Exchange Offer
The exchange offer is subject to the conditions that:
o we must receive valid tenders for at least 90% of the aggregate
principal amount of the outstanding old
junior subordinated debentures;
o we must receive the consent of the lenders, under Sierra's $135
million senior secured credit facility, which has been guaranteed by
us to our issuing the new senior subordinated debentures in the
exchange offer;
o we must receive the approval of the California Department of Insurance
required for one or more of our subsidiaries to directly or indirectly
fund all or part of the cash to be paid as the exchange consideration;
o we must obtain sufficient cash to pay any cash consideration required to
be paid as exchange offer consideration; and
o the exchange offer complies with applicable laws and applicable
interpretations of the staff of the SEC;
o the new senior subordinated debentures must be approved for listing on
the New York Stock Exchange;
o no litigation has been instituted or threatened or law enacted that
could prohibit the exchange offer, materially adversely affect our
business or materially impair the benefits of the exchange offer;
o no event has occurred affecting our business that could prohibit,
prevent or significantly delay consummation of the exchange offer, or
materially impair our contemplated benefits of the exchange offer; and
o no tender or exchange offer for our equity securities or any business
combination involving us has been proposed or announced or has
occurred.
Subject to satisfaction or waiver of the conditions, we will accept for
exchange any and all old junior subordinated debentures that are validly
tendered and not withdrawn before 5:00 p.m., New York City time, on the
expiration date of the exchange offer. However, we reserve the right to:
o delay the acceptance of your old junior subordinated debentures for
exchange;
o terminate the exchange offer;
o extend the expiration date and retain all old junior subordinated
debentures that have been tendered, subject to the right of owners of
the old junior subordinated debentures to withdraw their tendered old
junior subordinated debentures;
o refuse to accept the old junior subordinated debentures and return all
old junior subordinated debentures that have been tendered to us; or
o waive any condition or otherwise amend the terms of the exchange offer in
any respect.
United States Federal Income Tax Consequences of the Exchange Offer
You are referred to the discussion about the federal income tax
consequences of the exchange offer under "Material United States
Federal Tax
Consequences". Tax matters are very complicated and the tax consequences of the
exchange offer to you will depend on the facts of your own situation. You should
consult your own tax advisor for a full understanding of the tax consequences to
you of the exchange offer.
Exchange Agent
We have appointed Wells Fargo Bank Minnesota, N.A. as the exchange agent
for the exchange offer of the old junior subordinated debentures. We have agreed
to pay Wells Fargo Corporate Trust reasonable and customary fees for its
services and will reimburse Wells Fargo Corporate Trust for its reasonable
out-of-pocket expenses. All executed letters of transmittal and any other
required documents should be sent or delivered to the exchange agent at the
address set forth below. Questions and requests for assistance, requests for
additional copies of this prospectus or of the letter of transmittal and
requests for notices of guaranteed delivery should be directed to the exchange
agent, addressed as follows:
Wells Fargo Corporate Trust:
By Registered & Certified Mail:
WELLS FARGO BANK MINNESOTA, N.A.
Corporate Trust Operations
MAC N9303-121
PO Box 1517
Minneapolis, MN 55480
By Regular Mail or Overnight Courier:
WELLS FARGO BANK MINNESOTA, N.A.
Corporate Trust Operations
MAC N9303-121
Sixth & Marquette Avenue
Minneapolis, MN 55479
In Person by Hand Only:
WELLS FARGO BANK MINNESOTA, N.A.
12th Floor - Northstar East Building
Corporate Trust Services
608 Second Avenue South
Minneapolis, MN 55479
By Facsimile (for Eligible Institutions only):
(612) 667-4927
For Information or Confirmation by
Telephone:
(800) 344-5128
Delivery of a letter of transmittal to an address other than that for the
exchange agent as set forth above or transmission of instructions via facsimile
other than as set forth above does not constitute a valid delivery of a letter
of transmittal.
Dealer Manager
We have retained Banc of America Securities LLC as our exclusive dealer
manager in connection with the exchange offer. We will pay Banc of America
Securities LLC a customary fee for its services. We have also agreed to
reimburse Banc of America Securities LLC for its expenses and to indemnify it
against certain expenses and liabilities, including liabilities under federal
securities laws. These expenses are not included in the fees set forth above.
Information Agent
We have appointed D.F. King & Co., Inc., the information agent for the
exchange offer of the old junior subordinated debentures. We have agreed to pay
D.F. King reasonable and customary fees for its services and will reimburse D.F.
King for its reasonable out-of-pocket expenses. Any questions concerning the
exchange offer procedures or requests for assistance or additional copies of
this prospectus or the letters of transmittal may be directed to the information
agent at:
D.F. King & Co., Inc.
77 Water Street
New York, New York 10005
Banks and Brokers, call collect:
(212) 269-5500
Others, call toll free:
(800) 735-3591
Fees and Expenses
We will bear the expenses of soliciting tenders for the exchange offer. We
are making the principal solicitation by mail. However, we may make additional
solicitations by telephone, facsimile, e-mail or in person by officers and
regular employees of ours and those of our affiliates.
In addition, we may make payments to brokers, dealers or others soliciting
acceptance of the exchange offer. We will also pay the exchange agent reasonable
and customary fees for its services and will reimburse it for its reasonable
out-of-pocket expenses.
We will pay the cash expenses to be incurred in connection with the
exchange offer and are estimated in the aggregate to be approximately $1.6
million. Such expenses include fees and expenses of the exchange agent and
trustee, accounting and legal fees and printing costs, among others.
Payment of Solicitation Fee
We will pay to soliciting dealers a solicitation fee of $2.50 per $1,000 of
old junior subordinated debentures tendered, accepted for purchase and paid
pursuant to the exchange offer, provided, that the aggregate solicitation fee
paid to any one soliciting dealer shall not exceed $15,000. As used herein, a
"soliciting dealer" is an entity covered by a letter of transmittal which
designated its name as having solicited and obtained the tender, and is:
o any broker or dealer in securities, excluding the dealer manager, which
is a member of any national securities exchange or of the NASD;
o any foreign broker or dealer not eligible for membership in the NASD
which agrees to conform to the NASD's Rules of Fair Practice in
soliciting tenders outside the United States to the same extent as
though it were an NASD member; or
o any bank or trust company.
No such fee shall be payable to a soliciting dealer with respect to the
tender of old junior subordinated debentures by a holder unless the letter of
transmittal accompanying such tender designates such soliciting dealer. No such
fee shall be payable to a soliciting dealer in respect of old junior
subordinated debentures registered in the name of such soliciting dealer unless
such old junior subordinated debentures are held by such soliciting dealer as
nominee and such old junior subordinated debentures are being tendered for the
benefit of one or more beneficial owners identified on the letter of
transmittal. No such fee shall be payable to a soliciting dealer if such
soliciting dealer is required for any reason to transfer the amount of such fee
to a depositing holder (other than itself). No such fee shall be paid to a
soliciting dealer with respect to old junior subordinated debentures tendered
for such soliciting dealer's own account. No broker, dealer, bank, trust company
or fiduciary shall be deemed to be the agent of us, DTC, the dealer manager or
the information agent for purposes of the exchange offer. For all purposes noted
in all materials related to the exchange offer, the term "solicit" shall be
deemed to mean no more than "processing old junior subordinated debentures
tendered" or "forwarding to customers materials relating to the exchange offer."
We will also, upon request, reimburse soliciting dealers for reasonable and
customary handling and mailing expenses incurred by them in forwarding materials
relating to the exchange offer to their customers.
Transfer Taxes
Owners who tender their old junior subordinated debentures for exchange
will not be obligated to pay any transfer taxes. If, however,
o new senior subordinated debentures are to be delivered to, or issued in
the name of, any person other than the registered owner of the old junior
subordinated debentures; or
o old junior subordinated debentures are registered in the name of any
person other than the person signing the letter of transmittal; or
o a transfer tax is imposed for any reason other than the exchange of new
senior subordinated debentures for old junior subordinated debentures in
connection with the exchange offer;
then the amount of any transfer taxes, whether imposed on the registered owner
or any other persons, will be payable by the tendering holder. If satisfactory
evidence of payment of such taxes or exemption from them is not submitted with
the letter of transmittal, the amount of such transfer taxes will be billed
directly to the tendering holder.
No Appraisal Rights
You will not have any right to dissent and receive an appraisal of your old
junior subordinated debentures in connection with the exchange offer.
Listing
We have applied to list the new senior subordinated debentures on the New
York Stock Exchange. However, we do not expect the new senior subordinated
debentures to be listed until after 30 days following the consummation of the
exchange offer.
Accounting Treatment of the Exchange Offer
The new senior subordinated debentures will be recorded at the carrying
amount of the old junior subordinated debentures less cash consideration given,
if any, and that amount will be used to determine the effective interest rate of
the new senior subordinated debentures.
Fractional Debentures
We will issue new senior subordinated debentures in denominations of $1,000
and integral multiples of $1,000. Any fractional principal amount of new senior
subordinated debentures which a registered holder is entitled to receive as
exchange consideration will be paid in cash.
"Blue Sky" Compliance
We are making this exchange offer to all holders of old junior subordinated
debentures. We are not aware of any jurisdiction in which the making of the
exchange offer is not in compliance with applicable law. If we become aware of
any jurisdiction in which the making of the exchange offer would not be in
compliance with applicable law, we will make a good faith effort to comply with
any such law. If, after such good faith effort, we cannot comply with any such
law, the exchange offer will not be made to, nor will tenders of old junior
subordinated debentures be accepted from or on behalf of, the holders of old
junior subordinated debentures residing in such jurisdiction.
BUSINESS
General
We are a holding company whose subsidiaries, California Indemnity Insurance
Company, Commercial Casualty Insurance Company, Sierra Insurance Company of
Texas and CII Insurance Company are primarily engaged in writing workers'
compensation insurance in nine Western and Midwestern states. Substantially all
of our assets and our operations are conducted through our subsidiaries. In
addition, we have other smaller subsidiaries that we consider immaterial to our
overall results.
We were acquired by Sierra on October 31, 1995 in a transaction treated as
a pooling of interests. However, our old junior subordinated debentures remain
solely our obligation and Sierra has not guaranteed the payment of the
debentures.
Our subsidiaries write workers' compensation insurance in the states of
California, Colorado, Nevada, Texas, Nebraska, Kansas, Missouri, New Mexico and
Utah primarily through independent insurance agents and brokers, and have
licenses in 33 states and the District of Columbia and applications pending for
licenses in other states. California, Colorado and Nevada represented
approximately 77%, 8% and 7%, respectively, of our direct written premiums for
the nine months ended September 30, 2000.
We focus on writing lower-severity classes of workers' compensation
insurance for primarily small and mid-sized employers although we actively
pursue accounts of all sizes. This strategy allows us to direct our managed care
expertise to employers that may lack the in-house resources needed to manage
costs effectively and to return injured employees to work safely and quickly.
These techniques include the use of specialized preferred provider networks,
utilization review by our board certified occupational medicine physician and
the employment of nurse case managers, medical bill reviewers, and job
developers to facilitate early return to work. In particular, our Return to
Work, or RTW, Program has brought a large number of injured workers back to the
job more quickly and at a lower cost than would have otherwise been possible.
By focusing primarily on small and mid-sized employers, we seek to target
under-served segments of the workers' compensation market and avoid the price
competition associated with large accounts. As of September 30, 2000, we had
16,155 policies in force and an average policy size of approximately $11,700.
The following table sets forth the percentages of our written premiums in
force on September 30, 2000, December 31, 1999, and July 31, 1998 attributable
to the listed risk classifications identified as the policy holders governing
class:
September 30, 2000 Dec. 31, 1999 July 31, 1998
----------------------- ---------------------- -----------------------
Construction 31.20% 28.41% 26.63%
Manufacturing 15.33 15.97 14.69
Service Industry 12.58 12.82 12.27
Agriculture 11.92 11.80 11.39
Other (1) 28.97 31.00 35.02
----- ----- -----
Total 100.00% 100.00% 100.00%
- ------------------
(1) Includes all other risk classifications insured by us, none of which
accounted for more than 9.5% of our written premiums in force as of any of
the above dates.
Underwriting
Prior to insuring a particular risk, we review, among other factors, the
employer's prior loss experience and other pertinent underwriting information.
Additionally, we determine whether the employer's employment classifications are
among the classifications that we have elected to insure and if the amounts of
the premiums for the classifications are within our guidelines. We review these
classifications periodically to evaluate whether they are profitable. Of the
approximately 550 employment classifications in California, we are willing to
insure approximately two-thirds. The remaining classifications are either
excluded by our reinsurance treaty or are believed by us to be too hazardous or
not profitable. In addition, we increase our requirements for certain
classifications to increase the likelihood of profitability.
Once an employer has been insured by us, our loss control department may
assist the insured in developing and maintaining safety programs and procedures
to minimize on-the-job injuries and industrial health hazards. The safety
programs and procedures vary from insured to insured. Depending upon the size,
classifications and loss experience of the employer, our loss control department
will periodically inspect the employer's places of business and may recommend
changes that could prevent industrial accidents. In addition, severe or
recurring injuries may also warrant on-site inspections. In certain instances,
members of our loss control department may conduct special educational training
sessions for insured employees to assist in the prevention of on-the-job
injuries. For example, employers engaged in contracting may be offered a
training session on general first aid and prevention of injuries from specific
work exposures.
Claims
Our claims operation is organized into a centralized claims/managed care
service office in Las Vegas, Nevada, and four regional claims service offices.
Major claims, those of high severity, complex nature and/or which are expected
to exceed applicable reinsurance retention levels, are handled directly, or
supervised, by the reinsurance claims staff.
Our approach to claims administration relies upon a high level of
interaction with the injured worker and the insured to resolve claims in an
efficient and cost effective manner. Claims personnel act as the contact point
with the insured and refer the claim to the appropriate support services within
our managed care and Return To Work, or RTW, functions.
Sierra Health and Life Insurance Company. Effective December 2000, for all
claims other than from our Texas operation, we have contracted our medical
management, bill review, and return to work with Sierra Health and Life
Insurance Company's Workers' Compensation Managed Care Division. The arrangement
is at cost. The staff of the Managed Care Division, consists of 88 employees,
who were previously employed by California Indemnity Insurance Company in the
same capacities. Sierra Health and Life Insurance Company is a wholly-owned
subsidiary of Sierra.
We have sought to reduce medical and indemnity cost by minimizing
litigation and litigation expense, returning workers to work safely and quickly,
and having access to medical attention at competitive prices. We have sought to
accomplish this by:
o using statewide medical provider networks, the members of which have
agreed to provide hospital and physician services at reduced fee schedules;
o utilizing medical bill review services which advise us of any excess
charges submitted by providers;
o facilitating early return to work and managing vocational rehabilitation
costs;
o improving customer service to allow for faster reporting; and
o outsourcing legal defense.
Use of Managed Care. We use managed care techniques to manage claim costs.
Except where limited by law, our managed care strategy directs injured workers
to preferred provider organizations, which we refer to as PPO's, to take
advantage of rates negotiated by the PPO's with participating providers and to
utilize doctors who understand the procedures and communication required to
allow injured workers to return to work safely and quickly. This strategy has
led us to spend substantially less on medical costs than otherwise payable under
state established fee schedules. From 1995 to September 30, 2000, our use of
PPO's as a percentage of total medical bills where a saving was achieved, known
as "PPO penetration", increased from 25% to 50%. In addition to increasing PPO
penetration we also increased the savings from state established fee schedules
to 33% through September 30, 2000, from 22% of such schedules for 1995.
Management of the medical portion of any claim assists the employer in
managing the cost of the indemnity benefit. Our staff of nurses evaluates
lost-time cases and directs the injured employee to preferred providers. We
utilize a board certified occupational medicine physician as medical director to
provide prospective, concurrent, and retrospective review of inpatient
admissions. The medical director can communicate directly with treating
physicians to assist with the direction of appropriate and timely medical care.
By requesting the treating provider to obtain authorization prior to the
administration of medical care, we seek to receive medical justification for
proposed treatments, which often leads to more accurate medical diagnoses. We
have used the medical authorization process to reduce the costs associated with
over-treating or under-treating by medical care providers.
Medical Bill Review. We use medical bill reviewers to manage costs. By
performing the bill review work, we have increased our bill review savings as a
percentage of state fee schedules from 25% for 1995 to 38% for the nine months
ended September 30, 2000.
Return to Work, or "RTW", Program. A critical component of our claims
administration approach and our accompanying efforts to reduce indemnity costs
is our RTW Program. The program assigns certain claims to a RTW technician, who
contacts the injured worker's physician and employer to ascertain functional
capacity restrictions and determines whether the employee can perform modified
or temporary work. In an unmanaged environment, the doctor typically relies upon
the injured worker's description of job duties and bases the medical impairment
and disability status upon that subjective description. Such reliance on the
worker's description can lead to increased amounts of lost time and, therefore,
much higher indemnity payments by us. The RTW technician's task is to work with
the doctor and the employer to formally define job duties and to compare those
against functional capacity restrictions. This process allows the RTW technician
to determine the extent of job disability and the need for vocational
rehabilitation as required by the state. By being directly involved with the
assessment process, we not only strive to obtain an objective disability
diagnosis, but also provide a valuable service to our smaller insureds, who
typically do not have formalized processes for return to work.
Customer Service. Early claims reporting allows us to direct the injured
worker to in-network medical care providers, to enroll those workers in the RTW
program, and to reduce the chance of litigation. We have instituted a 24-hour
per day, seven days per week, toll free "800" telephone number that allows
employers to notify us of a potential claim as quickly as possible.
Our customer service call center directs policyholders and injured workers
to the nearest preferred health care facility and provides assistance to claims
examiners by asking specific investigative questions which allow the examiner to
make prompt claim decisions. The customer service representatives additionally
answer questions relating to provider bill status, pharmacy authorization, and
agent/employer requests for information.
California Health Care Organization. In December 2000, Sierra Health and
Life Insurance Company was licensed in California as a Health Care Organization
by the California Department of Managed Care.
A California Health Care Organization coordinates the health care delivery
system for the injured worker, including primary provider assignment, emergency
and inpatient care, physician consultations, referrals and diagnostic testing.
The Health Care Organization also provides quality assurance, medical management
and return to work assistance. These provisions afford better cost controls for
employers by allowing their injured employees access to medical providers
trained in workers' compensation issues. We expect to phase in the activities of
Sierra Health and Life as a California Health Care Organization beginning in the
Fresno, California market for the first three months of 2001, extending to other
markets in California later in the year.
Legal Defense. In April 1997, we discontinued our in-house claims legal
defense unit in Southern California and entered into a five-year contract with a
law firm specializing in the defense of workers' compensation claims. This legal
arrangement defines roles for the attorneys and claims personnel to maximize
efficient handling of litigated claims.
Competition
Workers' compensation is a statutory system that requires an employer to
provide its employees with medical care and other specified benefits for
work-related injuries, even though the injuries may have resulted from the
negligence or wrongs of a person, including the employee. Employers typically
purchase workers' compensation insurance to provide these benefits. The benefits
payable are generally established by statute.
The California workers' compensation insurance industry is extremely
competitive. Approximately 185 companies wrote workers' compensation insurance
in California in 1999, including the State Compensation Insurance Fund, which is
the largest writer in California. Many of these companies have been in business
longer, have a larger volume of business, offer a more diversified line of
insurance coverage, have greater financial resources and have greater
distribution capability than us. We believe that the dominant competitor in the
industry is the State of California Compensation Insurance Fund. We concentrate
on insuring workers' compensation accounts in the small to medium-size range,
where we compete primarily on the basis of service and where policyholder
dividends are not a significant factor.
Based on 1999 direct written premiums, we were the 13th largest writer of
workers' compensation insurance in California, with a 2% market share. Our
insurance subsidiaries are currently rated "B++" by A.M. Best.
The following table provides an illustration of our subsidiary, California
Indemnity Insurance Company, and the top 10 workers' compensation writers in the
state of California for 1999:
California Workers' Compensation Market
For the Year Ended December 31, 1999 (dollars in millions)
-------------------------------------------------- ------------------
Direct Written
Insurer Premiums Market Share
State Compensation Fund $ 1,244.7 21.6%
Fremont Comp Insurance Group* 520.4 9.0
Superior National Insurance Group* 482.2 8.4
Liberty Mutual Insurance 463.0 8.0
Fireman's Fund/Allianz 232.6 4.0
Kemper Insurance Companies 213.7 3.8
Farmers Insurance Group 184.6 3.2
Reliance Insurance* 184.1 3.2
Great American P&C 173.3 3.0
Legion Insurance Co. 173.0 3.0
California Indemnity Insurance Company 120.5 2.0
--------------------------------------------------- ----------------- -----------------
Source: California Workers' Compensation Institute Bulletin No. 00-15
* These three companies have significantly reduced their writings in
California or announced their intentions to do so. Fremont and Superior
each had an "E" (under regulatory supervision) rating by A.M. Best as
of December 10, 2000. Reliance had a "D" (poor) rating by A.M. Best as
of December 10, 2000.
Prior to 1995, California law set minimum rates. This minimum rate law was
repealed by the California legislature with policies issued or renewed on or
after January 1, 1995. From 1995 until the end of 1999, our pricing declined
significantly as competitors sought to write more business by cutting their
prices. Beginning in December 1999 we began achieving rate increases on renewing
policies. This increasing rate trend has continued through September 2000.
In other states in which we are currently writing business, competition for
workers' compensation insurance is primarily driven by pricing, dividend plans
and agents' commission. In these states, the National Council on Compensation
Insurance, or NCCI, is usually the designated rating organization. The NCCI
accumulates statistical information and recommends pure loss cost rates to each
state's department of insurance who has final approval authority. We then add
loss cost multipliers or expense loads to derive premium rates for each filed
company. Rating plans in NCCI states are more "standardized" pricing models
based upon plans (algorithms) developed by the NCCI and approved by departments
of insurance.
Both Colorado and Nevada have competitive and dominant state insurance
funds who represent the major competition in their respective states. In
Colorado, the state fund is Pennacol Insurance Company. In Nevada, it is
Employers Insurance Company of Nevada, formerly a state fund but now a private
mutual insurer. In addition to these two organizations, there are approximately
200 other companies competing for business in states outside of California. The
major competitive tool in NCCI states is the use of participating policies,
which grant policyholders' dividends, and policies with retrospective rated
premium. We currently write participating policies in Colorado, Nevada,
Missouri, Nebraska, New Mexico and Kansas.
Nevada is scheduled to change to an open rating environment from a minimum
rating environment beginning July 2001.
Losses and Loss Adjustment Expenses
Often, several years may elapse between the occurrence of a loss and the
final settlement of the loss. To recognize liabilities for unpaid losses, we
establish reserves, which are balance sheet liabilities representing estimates
of future amounts needed to pay claims and related expenses for insured events.
We also establish reserves for events that have been incurred but have not yet
been reported to us, which we refer to as "incurred but not reported" or "IBNR".
When a claim is reported, our claims personnel initially establish reserves
on a case-by-case basis for the estimated amount of the ultimate payment. These
estimates reflect the judgment of the claims personnel based on their experience
and knowledge of the nature and value of the specific type of claim and the
available facts at the time of reporting as to severity of injury and initial
medical prognosis. Included in these reserves are estimates of the expenses of
settling claims, including legal and other fees. Claims personnel adjust the
amount of the case reserves as the claim develops and as the facts warrant.
IBNR reserves are established for unreported claims and loss development
relating to current and prior accident years. In the event that a claim that
occurred during a prior accident year was not reported until the current
accident year, the case reserve for such claim typically will be established out
of previously established IBNR reserves for that prior accident year.
The National Association of Insurance Commissioners requires that we submit
a formal actuarial opinion concerning loss reserves with each statutory annual
report. The annual report must be filed with each applicable state department of
insurance on or before March 1 of the succeeding year. The actuarial opinion
must be signed by a qualified actuary as determined by the California Insurance
Commissioner. We retain the services of a qualified independent actuary to
periodically review our loss reserves.
The actuarial review for the year ended December 31, 1999 showed that our
loss and LAE reserves were below the actuary's projected estimate by
approximately $9 million and we recorded an increase to our reserves in December
1999 of $9.9 million. This reserve deficiency was primarily caused by adverse
loss development on California claims in accident years 1996 to 1998. Our
average cost per claim has increased each year since 1995 and the majority of
our claims occur in California. The entire California workers' compensation
industry has been adversely affected by higher claim severity. According to a
published estimate by the California Workers' Compensation Insurance Rating
Bureau in October 2000, the average ultimate loss per indemnity claim in
California increased 58% from accident year 1995 to accident year 1999. Factors
influencing this increase include rising average temporary disability costs, the
increase in the number of major permanent disability claims, medical inflation
and adverse court decisions related to medical control of claimant's treatment.
According to the California Workers' Compensation Institute, an industry
association, industry-wide workers' compensation medical costs in California
have far outstripped medical inflation, rising 15.3% in 1997, 15.8% in 1998 and
13.6% in 1999.
In the first six months of 2000 and especially in the second quarter, we
continued to see adverse reserve development on prior accident years and we had
our independent actuary perform a review of the June 30, 2000 reserves. As a
result of this review, we increased our reserves by $19.2 million, which was in
addition to a $1.5 million increase in the first quarter. The total net adverse
reserve development on prior accident years through September 30, 2000 was $20.2
million. The reserve deficiency was again primarily related to adverse reserve
development on California claims in accident years 1996 to 1999 and was due to
continuing increases in average claim costs.
We and an independent actuary test the adequacy of our reserves using
generally accepted actuarial methods. Both paid loss and incurred loss methods
are used to estimate the amount of the ultimate reserves. We also test our
reserves by comparing our paid losses and incurred losses to similar data
provided by the California Workers Compensation Insurance Rating Bureau for all
California workers' compensation insurance companies.
We review the adequacy of our reserves with our independent actuary
periodically and consider external forces such as changes in the rate of
inflation, the regulatory environment, the judicial administration of claims,
medical costs and other factors that could cause actual losses and LAE to
change. The actuarial projections include a range of estimates reflecting the
uncertainty of projections. Management evaluates the reserves in the aggregate,
based upon the actuarial indications and makes adjustments where appropriate.
Our consolidated financial statements provide for reserves based on the
anticipated ultimate cost of losses.
The following table sets forth the number of claims reported to us for the
nine month accident period ended September 30, 2000 and accident years ended
December 31, 1999, 1998 and 1997, and related direct earned premiums and claims
frequency, or the number of claims per million dollars of direct earned premium.
Nine
------------------- -----------------------------------------
months ended
September 30, Year ended December 31,
2000 1999 1998 1997
Number of claims reported during the period ended 15,600 17,200 18,600 18,100
Direct earned premiums (in millions) 150.1 146.7 154.0 134.2
Claims frequency 103.9 117.2 120.8 134.8
- -----------------------------------------------------------------------------
The following table sets forth, for the nine months ended September 30,
2000 and the years ended December 31, 1999, 1998, and 1997, the cumulative loss
ratio, net of reinsurance, for each accident year or nine-month period and also
shows the loss "development" for each of these accident periods' loss ratios.
Cumulative
-----------------------
Loss Ratios
Nine months ended Cumulative Loss Ratios
September 30, Year ended December 31,
Accident Year 2000 1999 1998 1997
1995 and prior 72.32% 72.05% 73.76% 76.60%
1996 93.22 89.60 85.72 83.84
1997 96.43 90.42 84.21 79.18
1998 85.87 83.64 77.45
1999 66.11 62.13
2000 70.20
- -----------------------------------------------------------------------------
The following table sets forth, for the nine months ended September 30,
2000 and the years ended December 31, 1999, 1998, and 1997, the cumulative loss
ratio, gross of reinsurance, for each accident year or nine-month period and
also shows the loss "development" for each of these accident periods' loss
ratios.
Cumulative
-----------------------
Loss Ratios Cumulative Loss Ratios
Nine months ended Year ended December 31,
September 30,
Accident Year 2000 1999 1998 1997
1995 and prior 72.36% 71.98% 73.54% 76.34%
1996 91.51 88.41 83.98 82.32
1997 95.91 90.08 84.42 81.32
1998 98.97 92.08 83.45
1999 110.65 96.48
2000 103.61
- ------------------------------------------------------------------------------
The liabilities for losses and loss adjustment expense, which we refer to
as LAE, are determined using loss evaluations and statistical projections and
represent estimates of the ultimate net cost of all unpaid losses and LAE
incurred through December 31 of each year. These estimates are subject to the
effect of trends in claim severity and frequency and are continually reviewed
and adjusted to reflect new experience and information, as it becomes known.
Such adjustments, if any, are reflected in current operations. Notwithstanding
the fact that the claims for which reserves are established may not be paid for
many years, the reserves for losses and LAE payments are not discounted, except
to calculate the liability for federal income taxes. The anticipated price or
cost increases due to inflation are considered in estimating ultimate claim
costs. Historical trends, adjusted to reflect anticipated changes in
underwriting standards, policy provisions and general economic trends, provide
the basis for predicting the severity of future claims. Actual developments are
monitored and anticipated trends are modified, if necessary.
The following table provides a reconciliation of beginning and ending
liability balances for the nine months ended September 30, 2000 and 1999 and
years ended December 31, 1999, 1998 and 1997.
Reconciliation of Liability for Loss and Loss Adjustment Expenses
(in thousands)
Nine months ended
September 30, --------------------------------------------
Year ended December 31,
2000 1999 1999 1998 1997
Net Beginning Loss and LAE Reserve $134,305 $174,467 $174,467 $181,643 $172,100
Net Provision for Insured Events Incurred in:
Current Year 63,843 36,061 51,540 103,990 102,302
Prior Years 20,177 (1,248) 9,920 (9,643) (8,970)
------ ------- ----- ------- -------
Total Net Provision 84,020 34,813 61,460 94,347 93,332
------ ------ ------ ------ ------
Net Payments for Loss and LAE
Attributable to Insured Events Incurred
- ---------------------------------------------
In:
Current Year 15,763 12,836 21,206 29,591 26,812
Prior Years 49,893 64,668 80,416 71,932 56,977
------ ------ -------- -------- -------
Total Net Payments 65,656 77,504 101,622 101,523 83,789
------ ------ ------- ------- -------
Net Ending Loss and LAE Reserve 152,669 131,776 134,305 174,467 181,643
Reinsurance Recoverable 189,233 81,367 110,089 37,797 21,056
------- -------- ------- -------- --------
Gross Ending Loss and LAE Reserve $341,902 $213,143 $244,394 $212,264 $202,699
======== ======== ======== ======== ========
We recognized favorable loss development as our losses were lower than
projected in calendar years 1997 and 1998 of $9.0 million and $9.6 million,
respectively. This favorable loss development reduced our incurred losses
reported in those calendar years and was mainly attributable to lower actual
paid claims than were previously reserved on accident years prior to 1995. In
calendar years 1991 and 1992, we experienced significant adverse loss
development on prior accident years and recorded reserve increases of $16.2
million and $28.1 million, respectively. The adverse development occurred
primarily on the 1990 and 1991 accident years and was attributable to what we
referred to as "stress and strain" claims, which were primarily psychological or
mental claims and were usually unaccompanied by any outward display of a
physical injury. The economic recession in California during this period
resulted in a significant increase in workers' compensation reported claims.
Benefits paid to a claimant were not subject to income taxes whereas
unemployment benefits were subject to income taxes. In establishing reserves in
1992 and subsequent periods, we tried to factor in this adverse development
trend. In 1993, California enacted workers' compensation reform laws, which,
along with an improving economy, substantially eliminated stress and strain
claims. We did not reduce our prior accident year reserves until we and our
actuary were satisfied that the claims payment trend was fully substantiated.
In calendar year 1999, we had adverse loss development of $9.9 million
which, as discussed above, was primarily due to higher average claims in
California on accident years 1996 to 1998. For the nine months ended September
30, 2000, we had additional adverse loss development of $20.2 million. This too,
as discussed above, was due to continuing higher average claims on accident
years 1996 to 1999.
The following table discloses our development of the liability for losses
and LAE for the nine months ended September 30, 2000 and the ten years ended
December 31, 1999.
ANALYSIS OF LOSSES AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
(in thousands)
Sept. 30, Year ended December 31,
2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990
Losses and LAE Reserve...$341,902 $244,394 $212,264 $202,699 $187,776 $182,318 $190,962 $200,356 $178,460 $112,749 $ 67,593
Less Reinsurance
- -------------------------
Recoverables (1)..........189,233 110,089 37,797 21,056 15,676 25,871 29,342 25,841 20,207
------- --------- --------- ------- --------- ------ ------- ------
Net Loss and LAE
Reserves............ 152,669 134,305 174,467 181,643 172,100 156,447 161,620 174,515 158,253
Net Reserve Re-estimated
as of (2)
1 Year Later.............. 154,482 184,386 172,000 163,130 141,163 139,741 160,562 154,388 140,815 83,841
2 Years Later............. 201,265 173,596 146,987 132,193 125,279 141,100 147,167 142,447 96,011
3 Years Later............. 187,491 140,563 113,766 117,792 126,483 134,747 143,433 97,142
4 Years Later............. 146,692 102,652 102,955 122,517 132,193 137,143 97,942
5 Years Later............. 104,400 95,997 114,443 131,112 135,249 94,852
6 Years Later............. 96,530 112,284 127,258 135,299 93,561
7 Years Later............. 112,506 125,936 133,729 93,672
8 Years Later............. 126,163 132,696 92,851
9 Years Later............. 132,906 92,104
10 Years Later............ 92,226
Cumulative Net Paid as of
(2):
1 Year Later.............. 49,893 80,416 71,933 56,977 45,731 44,519 50,210 50,360 57,611 39,118
2 Years Later............. 115,256 117,794 91,765 70,854 68,619 79,788 84,465 89,177 65,165
3 Years Later............. 137,737 113,054 83,674 80,645 94,865 104,569 108,849 76,988
4 Years Later............. 122,386 91,115 86,381 102,395 114,293 120,539 83,822
5 Years Later............. 94,557 89,601 106,012 119,462 126,100 87,618
6 Years Later............. 91,074 107,850 122,000 129,060 89,607
7 Years Later............. 108,785 123,291 130,649 90,721
8 Years Later............. 123,956 131,346 91,354
9 Years Later............. 131,744 91,598
10 Years Later............ 91,745
Cumulative (Deficiency)
Redundancy (2)......... (20,177) (26,799) (5,848) 25,408 52,047 65,090 62,009 32,090 (20,157) (24,633)
Net Reserve...............152,669 134,305 174,467 181,643 172,100 156,447 161,620 174,515
Reins. Recoverables.......189,233 110,089 37,797 21,056 15,676 25,871 29,342 25,841
------- --------- -- ------ -- ------ -- ------ -- ------ -- ------ -- ------
Gross Reserve.............$341,902 $244,394 $212,264 $202,699 $187,776 $182,318 $190,962 $200,356
======== ======== ======== ======== ======== ======== ======== ========
Net Re-estimated Reserve.. 154,482 201,265 187,491 146,692 104,400 96,530 112,506
Re-estimated Reins.
Recoverables........... 135,654 45,866 21,487 16,049 26,712 29,874 26,180
------- -- ------ -- ------ -- ------ -- ------ -- ------ -- ------
Gross Re-estimated
Reserve................ 290,136 247,131 208,978 162,741 131,112 126,404 138,686
-------- -------- -------- ------- ------- ------- -------
Gross Cumulative
(Deficiency)
Redundancy............. $(45,742) $(34,867) $ (6,279) $ 25,035 $51,206 $ 64,558 $ 61,670
========= ========= ========= ======== ======= ======== ========
(1) Amounts reflect reinsurance recoverable under prospective reinsurance
contracts and the cumulative amortization of retroactive reinsurance
recoverable. Unamortized retroactive reinsurance recoverable is excluded as
it does not reduce incurred losses under generally accepted accounting
principles. Reinsurance recoverables on unpaid losses and LAE are shown as
an asset on the balance sheets at September 30, 2000 and December 31, 1999
and 1998.
(2) The last amount in each column and the cumulative (deficiency) redundancy
represent development through nine months ended September 30, 2000.
Our average cost per claim has increased each year since 1995. The majority
of our claims occur in California. The entire California workers' compensation
industry has been adversely affected by higher claim severity. The average
ultimate loss per indemnity claim for California increased 58% from accident
year 1995 to accident year 1999, according to a published estimate of the
California Workers Compensation Insurance Rating Bureau in October 2000. Two of
the factors influencing this increase are medical inflation and adverse court
decisions related to medical control of claimant's treatment.
- -------------------------------------------------------------------------------
Unallocated loss adjustment expense reserves are established for the
estimated costs related to the general administration of the claims adjustment
process. We review the adequacy of our reserves on a periodic basis and consider
external forces such as changes in the rate of inflation, the regulatory
environment, the judicial administration of claims, medical costs and other
factors that could cause actual losses and loss adjustment expenses to change.
Reserves are reviewed with our independent actuary at least annually. The
actuarial projections include a range of estimates reflecting the uncertainty of
projections. Management evaluates the reserves in the aggregate, based upon the
actuarial indications, and makes adjustments where appropriate. Our financial
statements provide for reserves based on the anticipated ultimate cost of
losses.
Investments
As of September 30, 2000, our bond and preferred stock portfolio is
invested primarily in high quality investment grade securities, which represent
approximately 98% of total bond and preferred stock investments. The total bond
and preferred stock portfolio is comprised of approximately 28% in U.S. Treasury
securities; approximately 34% in U.S. Government-sponsored Agency securities;
approximately 12% in AAA-rated corporate bonds; approximately 20% in AA-rated
corporate bonds; approximately 4% in A-rated corporate bonds; and approximately
2% in BAA-rated or lower corporate bonds. As of September 30, 2000, there has
been no significant change in the composition of our bond and preferred stock
portfolio when compared to the portfolio at December 31, 1999.
In addition to our cash and cash equivalents, preferred stocks, and fixed
income bond portfolio, other investments include mortgage loans with a book
value of $16.5 million and a real estate limited partnership with a book value
of $7.1 million. The mortgage loan investments are comprised of approximately
$10.3 million in two commercial mortgages extended to Sierra and a subsidiary of
Sierra; approximately $4.6 million in relocation mortgages extended to our
current and former employees prior to the 1995 merger of Sierra and us; and
approximately $1.6 million in commercial mortgages extended to third parties.
While mortgages and mortgage-backed securities usually have a higher rate of
return than rated corporate and government bonds, we do face the potential risk
associated with having to reinvest these funds if interest rates drop and the
mortgages are prepaid. Since these mortgages are typically prepaid when rates
are lower we would probably have to reinvest in other securities with a lower
rate of return. The real estate limited partnership represents our interest in
the partnership which owns our Las Vegas headquarters. As of December 31, 2000,
the real estate of the limited partnership was sold to an unaffiliated third
party.
Approximately $22 million of our investment assets as of September 30, 2000
are booked as "assets held to maturity" according to FAS 115. Assets held to
maturity are carried at amortized cost; changes in the market value of these
assets do not affect their book value for reporting purposes under accounting
principles generally accepted in the United States of America.
We manage our investment portfolio to provide liquidity for claims and
other liabilities and to maximize total return within the financial constraints
of applicable regulatory guidelines and requirements. We manage liquidity by
estimating the timing of claims and operating expense payments and premium
revenues received as well as the timing of payments to and from our reinsurers.
During 2000, we had to reduce our estimates of premiums receipts and increase
our estimates of claims payments during the year This was primarily due to
negative cash flow resulting from paying more ceded premiums to our reinsurers
than had previously been projected. We successfully met these revised estimates
by selling a portion of our investment portfolio while trying to minimize net
realized capital losses.
The following table reflects investments, interest earned thereon and the
average annual yield on investments for the periods indicated:
Nine Months Ended
September 30, Years Ended December 31,
2000 1999 1998 1997
(dollars in thousands)
Total cash, cash equivalents and invested
assets at end of period $231,604 $226,572 $283,509 $278,479
Net investment income including net
realized gains and losses before taxes 10,757 15,395 20,229 17,361
Average annual yield on investment
- -----------------------------------------------
portfolio (before realized gains and
losses and taxes) 6.5% 6.2% 6.5% 6.2%
The following table sets forth information concerning the composition of
our investment portfolio at December 31, 1999:
Percent of
Amount Portfolio
Fixed maturities, at fair value: (dollars in thousands)
U.S. government and government agencies $114,358 54.7
AAA 14,380 6.9
AA 43,145 20.7
A 13,395 6.4
Less than A 4,107 2.0
----------- --- ---
Total fixed maturities, at fair value 189,325 90.7
Equity securities, at fair value 3,486 1.7
Mortgage loans receivable 9,375 4.5
Real estate partnership 6,559 3.1
------------ -------
Total investments $208,745 100.0
======== =====
Except for mortgage loans receivable, there were no significant changes
in the composition of the investment portfolio when compared to the portfolio at
September 30, 2000. Mortgage loans receivable increased by $7.2 million and were
due to a new loan of $7.4 million that we made to Sierra in the first quarter of
2000. The details of this loan are discussed below in the section "Certain
Transactions".
The following table sets forth the contractual maturity profile of our debt
and mortgage loan investments at September 30, 2000:
Fair Value Percent of
Maturity Amount Portfolio
- -------- ------ ---------
(dollars in thousands)
One year or less $14,441 7.3
More than one year, through five years 51,085 25.7
More than five years, through ten years 15,112 7.6
More than ten years, through fifteen years 18,408 9.3
More than fifteen years 99,654 50.1
Actual maturities may differ from contractual maturities because borrowers
may have the right to call or prepay obligations. There were no significant
changes in the composition of maturity values when compared to the portfolio at
September 30, 2000.
Reinsurance
Our insurance subsidiaries purchase reinsurance to reduce our liability on
individual policies and claims and catastrophic losses. However, we are still
responsible for the direct payment of all policy benefits and claims. We pay our
reinsurers a ceded premium, which is a reduction of our revenues, and the amount
is primarily calculated as a percentage of our earned premiums. Ceded incurred
losses are determined in a manner that is consistent with how we determine our
gross incurred losses and reduce the amount of our gross incurred losses and
loss adjustment expenses. Under generally accepted accounting principles, ceded
unpaid losses are recorded as a reinsurance recoverable asset. Our reinsurers do
not have to pay us for ceded losses until we have made payments on a claim and
our payment may have to exceed certain pre-determined levels before our
reinsurers become obligated to pay us. As of September 30, 2000 we had over $211
million of reinsurance recoverables from our reinsurers. A single reinsurer,
Travelers Indemnity Company of Illinois, which is rated A+ by the A.M. Best
Company, accounts for approximately 87% of this amount. Substantially all of the
recoverables are due from reinsurers rated A+ by the A.M. Best Company and all
reinsurance recoverables are considered to be collectible.
We historically and currently have excess of loss reinsurance agreements at
pre-determined amounts or retention levels that have varied throughout the years
depending on our statutory capital and the protection we believed to be prudent.
Prior to 2000, the non-catastrophic excess of loss layer, which we define to be
below $10 million per occurrence, was placed with General Reinsurance
Corporation, which is rated A+ by the A.M. Best Company. At September 30, 2000,
reinsurance recoverable balances due from this reinsurer represented
approximately 11% of the total.
Effective July 1, 1998, all claims with dates of injury occurring on or
after that date are reinsured under a quota share and excess of loss agreement,
which we refer to as "low level" reinsurance, with Travelers Indemnity Company
of Illinois . The low level reinsurance provides quota share protection for 30%
of the first $10,000 of each loss, and excess of loss protection of 75% of the
next $40,000 of each loss, and 100% of the next $450,000 on a per occurrence
basis. The maximum net loss retained on any one claim ceded under this treaty is
$17,000. This agreement continued until June 30, 2000, when we executed an
option for a twelve month extension relating to the run-off of policies in force
as of June 30, 2000, which covers claims arising under such policies during the
term of the extension.
In addition to the low level reinsurance, effective January 1, 2000 we
entered into a reinsurance contract that provides statutory (unlimited) coverage
for workers' compensation claims in excess of $500,000 per occurrence. The
contract is in effect for claims occurring on or after January 1, 2000 through
December 31, 2003. The reinsurer, National Union Fire Insurance Company, which
is rated A+ by the A.M. Best Company, has a limited ability to cancel this
treaty on each anniversary of inception during that period.
When the low level reinsurance agreement expired on June 30, 2000, as a
result of a general tightening of the reinsurance market as well as the impact
of the increased loss experience in California, a comparable type of reinsurance
program was unavailable in the market and those reinsurers which were offering
other forms of lower retention programs were charging premiums that we believed
were not cost justified. Therefore, effective July 1, 2000, we entered into a
reinsurance contract that provides $250,000 of coverage for workers'
compensation claims in excess of $250,000 per occurrence. The contract is in
effect for claims occurring on policies with effective dates beginning July 1,
2000 and thereafter. The reinsurer, also National Union Fire Insurance Company,
has the ability to cancel the treaty if written notice is provided 90 days prior
to each anniversary of inception. In total, reinsurance recoverable balances due
from this reinsurer at September 30, 2000 represented approximately 2% of the
total.
Marketing
Our insurance policies are sold primarily through independent insurance
agents and brokers, who may also represent other insurance companies. We believe
that independent insurance agents and brokers choose to market our insurance
policies because of the quality of service that we provide, the commissions we
pay and the price of the insurance product. We employ full-time employees as
marketing representatives to make personal contacts with agents and brokers, to
maintain regular communication with them, to advise them of our services and
products, and to recruit additional agents and brokers. We currently have
relationships with approximately 900 agents and brokers and pay our agents and
brokers commissions based on a percentage of the gross written premium produced
by such agents and brokers. In 2001, we anticipate a reduction in the number of
agents resulting from more stringent volume and profitability standards we
imposed.
We maintain standard commission plans that vary by state for our agents and
brokers. In addition to the standard commission plans, agents and brokers may be
eligible to receive additional commissions in certain instances. Commissions,
including additional commissions if any, are negotiated on an individual policy
basis. No one agent or broker accounted for more than 1.7% of our total premiums
in force on September 30, 2000, and no one policy accounted for more than 0.6%
of our total premiums in force on September 30, 2000. Our top 10 agents and
brokers accounted for 12.2% of our total premiums in force September 30, 2000.
From time to time, we advertise and participate in insurance trade association
functions to maintain existing relationships and develop new ones.
Geographic Distribution of Premiums and Policy
The following tables set forth information concerning the percentages of
premiums and policies in force with us by geographic area as of September 30,
2000, and as of December 31, 1999, 1998 and 1997. In force premiums are the
total estimated annual premiums of all policies in force at a point in time.
September 30, December 31,
2000 1999 1998 1997
---- ---- ---- ----
Percent of premiums in force:
California 77% 80% 83% 83%
Nevada 8 4 0 0
Colorado 8 8 8 10
Other States 7 8 9 7
------------------ ------------ ------------ ------------
------------------ ------------ ------------ ------------
Total 100% 100% 100% 100%
================== ============ ============ ============
================== ============ ============ ============
Total premiums in force (in thousands): $189,557 $154,963 $132,789 $128,840
Percent of policies in force:
California 74% 79% 80% 84%
Nevada 7 3 0 0
Colorado 7 6 6 6
Other States 12 12 14 10
------------------ ------------ ------------ ------------
------------------ ------------ ------------ ------------
Total 100% 100% 100% 100%
================== ============ ============ ============
================== ============ ============ ============
Total policies in force 16,155 15,485 12,624 11,779
- -----------------------------------------------------------------------------
Government Regulation and Recent Legislation
We are subject to extensive governmental regulation and supervision in each
state in which we conduct workers' compensation business. The primary purpose of
such regulation and supervision is to provide safeguards for policyholders and
injured workers rather than protect the interests of shareholders or creditors.
The extent and form of the regulation may vary, but generally has its source in
statutes that establish regulatory agencies and delegate to the regulatory
agencies broad regulatory, supervisory and administrative authority. Typically,
state regulations extend to such matters as licensing companies; restricting the
types or quality of investments; requiring triennial financial examinations and
market conduct surveys of insurance companies; licensing agents; regulating
aspects of a company's relationship with its agents; restricting use of some
underwriting criteria; regulating premium rates, forms and advertising; limiting
the grounds for cancellation or nonrenewal of policies; solicitation and
replacement practices; and specifying what might constitute unfair practices.
In the normal course of business, we and the various state agencies that
regulate our activities may disagree on interpretations of laws and regulations,
policy wording and disclosures or other related issues. These disagreements, if
left unresolved, could result in administrative hearings and/or litigation. We
attempt to resolve all issues with the regulatory agencies, but are willing to
litigate issues where we believe we have a strong position. The ultimate outcome
of these disagreements could result in sanctions and/or penalties and fines
assessed against us. Currently, there are no litigation matters pending with any
department of insurance.
State holding company acts also regulate changes in control of insurance
holding companies, such as the transactions and dividends between an insurance
company and its parent or affiliates. Although the specific provisions vary,
holding company acts generally prohibit a person from acquiring a controlling
interest in an insurer unless the insurance authority has approved the proposed
acquisition pursuant to applicable regulations. In many states, including
California, where the insurance subsidiaries are incorporated, "control" is
presumed to exist if 10% or more of the voting securities of the insurance
holding company are owned or controlled by one person or entity. In addition,
the insurance authority may find that "control" in fact does or does not exist
where one person or entity owns or controls either a lesser or greater amount of
securities. The holding company acts also impose standards on certain
transactions with related companies and individuals which include, among other
requirements, that all transactions are to be fair and reasonable and that
transactions exceeding specified limits receive prior regulatory approval.
Typically, states mandate participation in insurance guaranty associations,
which assess solvent insurance companies in order to fund claims of
policyholders of insolvent insurance companies. Under this arrangement, insurers
can be assessed up to 1%, or 2% in certain states, of premiums written for
workers' compensation insurance in that state each year to pay losses and LAE on
covered claims of insolvent insurers. In California and certain other states,
insurance companies are allowed to recoup such assessments from policyholders
while several states allow an offset against premium taxes. The California
Insurance Guarantee Association has issued an assessment as a result of the
insolvency of the insurers owned by Superior National Insurance Group. The
assessment is 1% of 1999 written premium to be paid in two installments on
December 31, 2000 and June 30, 2001. The payments of approximately $1.2 million
will be recouped during 2001 and 2002 through assessments to policyholders. It
is likely that Guarantee Fund assessments related to this insolvency will
continue.
Besides state insurance laws, we are subject to general business and
corporation laws, federal and state securities laws, consumer protection laws,
fair credit reporting acts and other laws regulating the conduct and operation
of our subsidiaries.
Dividends
Our insurance subsidiaries are restricted by state law as to the amount of
dividends that can be declared and paid to us.
Moreover, insurance companies domiciled in California and Texas generally
may not pay extraordinary dividends without providing the state insurance
commissioner with 30 days' prior notice, during which period the commissioner
may disapprove the payment. An "extraordinary dividend" is generally defined as
a dividend whose fair market value together with that of other dividends or
distributions made within the preceding 12 months exceeds the greater of ten
percent of the insurer's surplus as of the preceding December 31 or the income
of such insurer for the 12-month period ending on the preceding December 31.
In addition, our insurance subsidiaries may not pay a dividend without the
prior approval of the state insurance commissioner to the extent the cumulative
amount of dividends or distributions paid or proposed to be paid in any year
exceeds the amount shown as unassigned funds (reduced by any unrealized gains
included in such amount) on the insurer's statutory statement as of the previous
December 31. California Indemnity, which is our only direct subsidiary, cannot
currently pay any dividends to us without the prior approval of the California
Department of Insurance. We are not in a position to assess the likelihood of
obtaining future approval for the payment of dividends other than those
specifically allowed by law in each of our subsidiaries' state of domicile.
No prediction can be made as to whether any legislative proposals relating
to dividend rules in the domiciliary states of our subsidiaries will be made or
adopted in the future, whether the insurance departments of such states will
impose either additional restrictions in the future or a prohibition on the
ability of our regulated subsidiaries to declare and pay dividends or as to the
effect of any such proposals or restrictions on our regulated subsidiaries.
Deposits and Other Requirements
Our insurance subsidiaries are required by state regulatory agencies to
maintain certain deposits for the benefit of policyholders or claimants and must
also meet certain net worth and reserve requirements. Our insurance subsidiaries
have assets on deposit for the benefit of policyholders in various states
totaling $152,356,000 at September 30, 2000.
Legal Proceedings
We are subject to various claims and other litigation in the ordinary
course of our business. Such litigation includes workers' compensation claims by
injured workers and by providers for payment for medical services rendered to
injured workers. In the opinion of our management, the ultimate resolution of
pending legal proceedings is not expected to have a material adverse effect on
our financial condition.
Employees
At September 30, 2000, we had a total of 404 full-time equivalent
employees, which we refer to as FTE's, grouped into underwriting, claims,
marketing and administrative functions. With the completion of our 1997-1998
restructuring and the commencement of Nevada operations in 1999, 157.5 of our
FTE's are located at the headquarters in Las Vegas, while 143.3 work at the
Pleasanton, California office, and 63 work at the Burbank, California office. In
addition, we have full-service branch offices in Denver, Colorado and Dallas,
Texas, which employ 20 and 16 FTE's respectively. We have two FTE's in Reno,
Nevada and two FTE's in Gladstone, Missouri.
Facilities
Our principal executive offices and the Las Vegas, Nevada branch office are
comprised of 41,005 square feet of office space subleased from Sierra through
December 31, 2001. We have an option to renew this sublease yearly for up to 14
more years. Our Northern California branch office, comprised of approximately
34,975 square feet of office space leased through October 31, 2002, is located
in Pleasanton, California. Our Southern California branch office, comprised of
23,250 square feet of office space leased through September 30, 2003, is located
in Burbank, California. We also lease space in other locations where we have
operations and believe our facilities are adequate for our current needs.
SELECTED FINANCIAL AND OTHER DATA
The table below presents our selected consolidated financial information
for the periods indicated and at the end of these periods. The consolidated
financial statement information as of December 31, 1999 and 1998 and for the
years ended December 31, 1999, 1998 and 1997 was derived from our consolidated
financial statements included elsewhere in this prospectus. These financial
statements were prepared in accordance with accounting principles generally
accepted in the United States of America, and were audited by Deloitte & Touche
LLP. The consolidated financial information at December 31, 1997 and for the
year ended December 31, 1996 was derived from our unaudited consolidated
financial statements for that year and the consolidated financial information
for the year ended December 31, 1995 was derived from our audited consolidated
financial statements for that year. The consolidated financial statement
information at September 30, 2000 and for the nine months ended September 30,
2000 and 1999 has been derived from our unaudited consolidated financial
statements included elsewhere in this prospectus. The unaudited consolidated
financial statements have been prepared by us on a basis consistent with the
audited financial statements and included all normal recurring adjustments
necessary for a fair presentation of the information set forth therein.
Operating results for the nine months ended September 30, 2000 are not
necessarily indicative of the results that will be achieved for future periods,
including the entire year ending December 31, 2000.
Nine Months Ended ----------------------------------------------------------
September 30, Year Ended December 31,
(dollars in (dollars in thousands)
thousands)
2000 1999 1999 1998 1997 1996 1995
---- ---- ---- ---- ---- ---- ----
Income Statement Data:
Direct written premiums $153,034 $106,291 $148,824 $153,914 $135,580 $126,724 $94,953
Net written premiums $93,857 $60,833 $85,097 $134,147 $130,597 $121,555 $90,926
Net earned premiums $90,951 $58,254 $82,955 $134,274 $129,197 $120,951 $90,584
Net investment income and net
realized gains =========
10,757 11,901 15,395 20,229 17,361 18,689 14,454
Other revenue 0 0 0 0 0 0 3,547
Total revenues 101,708 70,155 98,350 154,503 146,558 139,640 108,585
Total costs and expenses 115,715 58,301 91,255 136,625 135,745 129,010 99,502
(Loss) income from continuing
operations before federal ---------
income taxes, discontinued
operations, and extraordinary
gain
(14,007) 11,854 7,095 17,878 10,813 10,630 9,083
Federal income tax (benefit)
expense ---------
(4,902) 4,815 3,602 4,166 272 (896) (750)
(Loss) income from continuing
operations before discontinued
operations and extraordinary
gain (9,105) 7,039 3,493 13,712 10,541 11,526 9,833
Net loss from discontinued
operations 0 0 0 0 0 0 (6,600)
Extraordinary gain from debt
extinguishment, net of tax ----------
--------- ----------
654 0 111 48 2 58 0
Net (loss) income $(8,451) $7,039 $3,604 $13,760 $10,543 $11,584 $3,233
- ----------------------------------
Nine Months Ended
September 30, ----------------------------------------------------------
Year Ended December 31,
(dollars in (dollars in thousands)
thousands)
2000 1999 1999 1998 1997 1996 1995
---- ---- ---- ---- ---- ---- ----
Combined Ratios:
GAAP Combined Ratio:
Loss ratio 92.38% 59.76% 74.08% 70.26% 72.24% 72.69% 59.72%
Underwriting expense ratio(1) 28.59% 35.61% 31.45% 28.45% 29.67% 30.54% 44.75%
Combined ratio 120.97% 95.37% 105.53% 98.71% 101.91% 103.23% 104.47%
Statutory Combined Ratio:
Loss ratio 96.32% 61.07% 78.73% 71.03% 72.24% 72.69% 59.72%
Underwriting expense ratio 30.10% 37.53% 32.48% 28.92% 29.56% 30.48% 40.89%
Combined ratio 126.42% 98.60% 111.21% 99.95% 101.80% 103.17% 100.61%
Balance Sheet Data:
Total cash, cash equivalents and
invested assets $231,604 $238,864 $226,572 $283,509 $278,479 $261,846 $244,396
Total assets 492,852 380,766 404,338 379,880 343,022 315,895 303,151
Total debt 47,059 51,196 50,498 51,251 54,467 54,497 56,800
Total liabilities 434,338 309,669 338,285 305,933 285,452 270,975 260,977
Total stockholder's equity 58,514 71,097 66,053 73,947 57,570 44,920 42,174
- -----------------------------------
(1) Includes policyholders' dividend ratio of 1.83% for the nine months ended
September 30, 2000.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- ------------------------------------------------------------------------------
You should read the following discussion in conjunction with the
consolidated financial statements of CII Financial and the related notes, which
appear elsewhere in this prospectus and Annex 1 to this prospectus which
contains a glossary of terms. Any forward-looking statements contained in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations and any other sections of this prospectus need to be considered in
connection with the Risk Factors discussed earlier in this prospectus.
- -------------------------------------------------------------------------------
Our operating results are primarily the results of our workers'
compensation insurance subsidiaries and consist of underwriting profit/loss, net
investment income, net realized gains/losses, other income/expense, interest
expense on the old junior subordinated debentures, and income taxes.
Results of Operations for the Nine Months Ended September 30, 2000
Compared to the Nine Months Ended September 30, 1999
Our income before taxes decreased by $25.9 million for the nine months
ended 2000 compared to 1999. The major components of the change were:
o $32.7 million increase in net earned premiums; o $0.9 million decrease in
investment income; o $49.2 million increase in loss and loss adjustment
expenses; o $2.9 million increase in policy acquisition costs; and
o $2.4 million increase in general, administrative and other expenses.
Revenues:
Our revenue is comprised of net earned premiums, net investment income and
net realized gains/losses. Total revenue increased by 45% for the nine months
ended September 30, 2000 compared to 1999. The increase was largely due to a
larger amount of written premiums. The components increasing written premiums
included a 17% composite increase in premium rates for all states and a 25%
increase in production growth.
Net earned premiums are the end result of direct written premiums, plus
the change in unearned premiums, less premiums ceded to reinsurers. Our direct
written premiums increased by 44% due primarily to growth in California and
Nevada. Partially offsetting the growth in direct written premiums was an
increase in premiums ceded to reinsurers, which increased by 30%. The growth in
ceded reinsurance premiums was lower than the growth in direct written premiums
primarily due to the expiration of our low level reinsurance agreement on June
30, 2000 and new lower cost reinsurance agreements, all of which reduced the
percentage of premiums being ceded.
As compared to the low level reinsurance agreement that expired on June 30,
2000, the new lower cost reinsurance agreements will result in higher net earned
premium revenues, as we will be retaining more of the premium dollars, but also
lead to our keeping more of the incurred losses. This may result in a higher
loss and LAE ratio if the percentage increase in the additional incurred losses
should be greater than the percentage increase in the additional premiums we
retained. The effect on the balance sheet will result in a lower amount of
reinsurance recoverables. However, due to the length of time that it typically
takes to fully pay a claim, we should see an increase in cash flow and amounts
available to be invested.
The following table shows a comparison of direct written premiums, by
state, for the nine months ended September 30, 2000 and 1999:
Nine Months Ended September 30,
2000 % of total 1999 % of total
(dollars in millions)
California $117.6 76.9% $ 86.5 81.4%
Colorado 12.4 8.1 9.1 8.6
Nevada 11.3 7.4 0.8 0.7
Texas 5.6 3.6 5.5 5.2
Other States 6.1 4.0 4.4 4.1
--------- ------- --------- ------
Total $153.0 100.0% $106.3 100.0%
====== ===== ====== =====
- -------------------------------------------------------------------------------
As shown in the preceding table, our largest premium state, California, had
the largest increase in written premiums. For the nine months ended September
30, 2000, we have obtained an average premium rate increase on renewing policies
of approximately 25%. The market-pricing environment in California has become
more favorable since 1999 in reaction to industry-wide losses in the workers'
compensation line, increased reinsurance costs and competitors retreating from
the market. In Nevada, we began writing premiums on July 1, 1999, which was the
first date private carriers were allowed to issue workers' compensation policies
in the state.
Premiums in force are an indicator of future written premium trends.
Inforce premiums are the total estimated annual premiums of all policies in
force at a point in time. Total inforce premiums increased by 36% to
$189,557,000 at September 30, 2000. Total inforce premiums have dropped slightly
(.05%) from its highest point in the last twelve months which was in August
2000. This indicates a potential slowing trend in premiums written, especially
in California, due largely to business lost because of the higher premium rate
increases we have been trying to obtain. The number of inforce policies at
September 30, 2000 has also dropped by 1.3% from its highest point in the last
twelve months, which was also August 2000.
Effective July 1, 1998, we entered into what we refer to as a "low level"
reinsurance agreement. See Losses and Loss Adjustment Expenses below for further
details on this agreement. The favorable terms of the low level reinsurance
agreement provided us with an improved loss ratio as we reinsured a significant
amount of losses to the reinsurer. However, the ceded premiums we paid the
reinsurer reduced the cash available for investment and temporarily created
negative cash flow for us. The $900,000 or 7% reduction in net investment income
for the nine months ended September 30, 2000, compared to the prior period, is
due to a reduction in investments primarily because of higher ceded premiums
paid to reinsurers in 2000.
We had net realized losses of $460,000 for the nine months ended September
30, 2000 compared to net realized losses of $174,000 for the prior period. We
have tried to manage our investment portfolio to minimize unplanned sales of our
available-for-sale investments.
Losses and Loss Adjustment Expenses:
The $49.2 million increase in losses and loss adjustment expenses, which we
refer to as LAE, is attributable to the following reasons:
o Approximately $19.5 million of the increase is related to our premium growth.
o We recorded $20.2 million of net adverse loss development for prior
accident years. The net adverse development recorded in 2000 for the
prior accident years, primarily 1996 to 1999, was largely attributable
to higher costs per claim, or claim severity, in California. Higher
claim severity has had a negative impact on the entire California
workers' compensation industry. See our discussion above in "Business
- Losses and Loss Adjustment Expenses."
o We are establishing a higher loss and LAE ratio for the 2000 accident
year, which has resulted in an increase of approximately $8.3 million.
In light of the net adverse loss development we recorded in the fourth
quarter of 1999 of $9.9 million and the lower premium rates on
policies written in o 1999, we believed it prudent to establish the
2000 accident year reserves at a higher rate.
o The remaining difference is due to the expiration of the low level
reinsurance policy on June 30, 2000. We have a higher risk exposure on
policies effective after that date, which results in a higher amount
of net incurred loss and LAE.
Under our low level reinsurance agreement, we reinsure 30% of the first
$10,000 of each claim, 75% of the next $40,000 and 100% of the next $450,000.
The maximum net loss retained on any one claim ceded under this agreement is
$17,000. This agreement covered all policies in force at July 1, 1998 and
continued until June 30, 2000 when we executed an option to extend coverage to
all policies in force as of June 30, 2000. For policies effective from July 1,
2000, we obtained excess of loss reinsurance for 100% of the losses above
$250,000 and less than $500,000. We already had an existing excess of loss
reinsurance agreement that covered 100% of the losses above $500,000.
As a percentage of net earned premiums, the loss and LAE ratio for the nine
months ended September 30, 2000 was 92.4% compared to 59.8% for 1999. The 2000
loss ratio was significantly impacted by the $20.2 million net adverse
development, which represents 22.2% of net earned premiums. In addition, the
expiration of the low level reinsurance agreement is resulting in a higher loss
and LAE ratio on policies effective after June 30, 2000 as we are keeping more
of the losses.
Underwriting Expenses:
Underwriting expenses consist of policy acquisition costs and other
underwriting costs. Policy acquisition costs are those expenses that are
directly related to, and vary with, written premiums. Examples of policy
acquisition costs are commissions and allowances paid to agents and brokers,
premium taxes, boards and bureau fees and certain operating expenses primarily
related to our underwriting and marketing departments. The increase in policy
acquisition costs of $2.9 million for the nine months ended September 30, 2000
compared to 1999 is primarily attributable to the increase in net earned
premiums. Other underwriting expenses increased by $0.7 million for the nine
months ended September 30, 2000 compared to 1999 due to higher personnel costs
to service the increase in premium growth. As a percentage of net earned
premiums, the underwriting expense ratio was 28.6% in 2000 compared to 35.6% in
1999. The improvement in the expense ratio was due in part to higher net earned
premiums, which provides a larger base to spread our fixed costs, smaller growth
in personnel expenses and lower agents' commissions and allowances.
General, Administrative and Other Expenses:
Included in this income statement line item are other underwriting expenses
of $15.7 million for the nine months ended September 30, 2000
compared to $15.0
million for the prior year period. Also included are policyholders' dividends of
$1.7 million for the nine months ended September 30, 2000 compared to nil in
1999. The majority of the dividends are for Nevada participating policies and
represent 1.8% of net earned premiums. In addition, in 2000, we wrote-off
capitalized costs of $3.0 million on an information system software project that
was cancelled because the vendor was unable to fulfill its contractual
obligations.
Combined Ratio:
The combined ratio is a measurement of underwriting profit or loss and is
the sum of the loss and LAE ratio, underwriting expense ratio and policyholders'
dividend ratio. A combined ratio of less than 100% indicates an underwriting
profit. Our combined ratio was 121.0% for the nine months ended September 30,
2000 compared to 95.4% for the same period in 1999. The increase was primarily
due to a higher loss and LAE ratio of 32.6 percentage points, offset slightly by
a decrease in the underwriting expense ratio of 8.8 percentage points and a new
policyholders' dividends ratio of 1.8 percentage points. The increase in the
loss and LAE ratio was due to:
o net adverse loss development of $20.2 million, which represents 22.2%
of net earned premiums, on prior accident years recorded in 2000
compared to no loss development for the nine months ended 1999; and
o higher loss and LAE ratio on the 2000 accident year, which represents
9.1% of net earned premiums. The higher loss and LAE ratio is due in
part to the net adverse loss development we recorded in the fourth
quarter of 1999 of $9.9 million and to the lower premium rates on
policies written in 1999.
Income Taxes:
For the nine months ended September 30, 2000, we recorded a tax benefit of
$4.9 million compared to a tax provision of $4.8 million in the prior year
period. The effective tax rate was 35% for the 2000 period compared to 41% for
the 1999 period. The decrease in the effective tax rate was due to deferred
income tax valuation allowances recorded in 1999.
Results of Operations for the Year ended December 31, 1999 Compared to the Year
Ended December 31, 1998
Our income before taxes decreased by $10.8 million for the year ended
December 31, 1999 compared to 1998. The major components of the change were:
o $51.3 million decrease in net earned premiums; o $2.5 million decrease in
investment income; o $2.4 million decrease in net realized gains;
o $32.9 million decrease in loss and loss adjustment expenses; and o $12.9
million decrease in policy acquisition costs.
Revenues:
Our revenue is comprised of net earned premiums, net investment income and
net realized gains/losses. Total revenue decreased by 36% for the year ended
December 31, 1999 compared to 1998 and was due to a significant reduction in net
earned premiums. In addition, negative cash flows from operations resulted in
lower net investment income.
Net earned premiums are the end result of direct written premiums, plus the
change in unearned premiums, less premiums ceded to reinsurers. Our direct
written premiums decreased by $5.1 million or 3% due primarily to lower prices
for workers' compensation insurance in California. The increase in ceded
reinsurance premiums of $44.0 million was primarily due to the low level
reinsurance agreement, which is discussed below.
The following table shows a comparison of direct written premiums, by
state, for the year ended December 31, 1999 and 1998:
Year Ended December 31,
1999 % of total 1998 % of total
(dollars in millions)
California $120.5 80.9% $129.3 84.0%
Colorado 12.3 8.3 12.0 7.8
Texas 7.2 4.8 8.1 5.3
Nevada 2.6 1.8 0.0 0.0
Other States 6.2 4.2 4.5 2.9
-------- ------- ------- -------
Total $148.8 100.0% $153.9 100.0%
====== ====== ====== =====
Our largest premium state, California, also had the largest decrease in
written premiums due in large part to increasing price competition. The
market-pricing environment in California became less favorable at the end of
1998 due to some competitors using reinsurance as a way of reducing premium
rates to gain market share. We began writing workers' compensation insurance in
Nevada on July 1, 1999, the first date private insurance carriers were allowed
to issue workers' compensation policies in the state.
- ------------------------------------------------------------------------------
Premiums in force are an indicator of future written premium trends.
Inforce premiums are the total estimated annual premiums of all policies in
force at a point in time. Although direct premium writings decreased for the
year ended December 31, 1999 compared to 1998, total inforce premiums at
December 31, 1999 increased by 17% to $155.0 million. This indicates an upward
trend in premium growth, especially in California, in the latter part of 1999.
The number of inforce policies at December 31, 1999 also increased by 23% to
15,485.
Effective July 1, 1998, we entered into what we refer to as a "low level"
reinsurance agreement. See Losses and Loss Adjustment Expenses below for further
details on this agreement. The favorable terms of the low level reinsurance
agreement provided us with an improved loss ratio as we reinsured a significant
amount of losses to the reinsurer. However, the ceded premiums we paid the
reinsurer reduced the cash available for investment and temporarily created
negative cash flow for us. The negative cash flow created by the low level
reinsurance agreement was the primary reason for the lower net investment income
of $2.5 million.
We had net realized losses of $381,000 for the year ended December 31, 1999
compared to net realized gains of $2.0 million in 1998. We try to manage our
investment portfolio to minimize unplanned sales of our available-for-sale
investments. In 1998, we sold some of our investments in debt securities and
realized some gains.
Losses and Loss Adjustment Expenses:
The $32.9 million decrease in the losses and LAE is attributable to the
following reasons:
o Due to the low level reinsurance agreement, our reinsurer is at risk
for more of our losses and LAE on policies in force at July 1, 1998.
This agreement reduced the dollar amount of losses and LAE for the
year ended December 31, 1999 by approximately $70 million.
o We recorded $9.9 million of net adverse loss development for prior
accident years in the fourth quarter of 1999 compared to net favorable loss
development of $9.6 million in 1998. The net adverse development recorded in
1999 was primarily attributable to higher costs per claim, or claim severity, in
California on accident years 1996 to 1998. The entire California workers'
compensation industry has been adversely affected by higher claim severity.
See our discussion above in "Business - Losses and Loss Adjustment
Expenses." The number of reported claims per $1 million of earned premium, or
claims frequency, did not significantly change when compared to our historical
patterns. The net favorable loss development recorded in 1998 was due to lower
than expected loss and LAE payments, primarily on accident years 1992 to 1995.
Due to adverse reserve trends that we experienced in calendar years 1991 and
1992, we established reserves on accident years 1992 through 1995 at higher
levels so as to avoid future adverse development. Actual loss payments have come
in at levels below our projections and this favorable development was taken into
income only after we and our outside actuary were satisfied that the development
was substantially complete.
o The amount of direct losses and LAE reserves (i.e., before deducting
reinsurance recoveries) recorded in 1999 were higher by approximately
$22 million due to the trend in higher claim severity. This was
partially offset by an increase in excess reinsurance recoverable of
$4.5 million. In 1998, we recorded favorable loss development and this
trend was factored into the loss ratio to record the 1999 accident
year reserves.
Under our low level reinsurance agreement, we reinsure 30% of the first
$10,000 of each claim, 75% of the next $40,000 and 100% of the next $450,000.
The maximum net loss retained on any one claim ceded under this agreement is
$17,000. This agreement covered all policies in force at July 1, 1998. We also
had excess of loss reinsurance agreements that covered 100% of the losses above
$500,000 to $100 million.
As a percentage of net earned premiums, the loss and LAE ratio for year
ended December 31, 1999 was 74.1% compared to 70.3% for 1998. The increase is
due to the following:
o The $9.9 million of net adverse loss development for prior accident
years recorded in the fourth quarter of 1999 compared to favorable
loss development of $9.6 million in 1998 accounts for an increase in
the loss and LAE ratio of approximately 19 percentage points.
o The additional amounts of ceded losses and LAE due to the low level
reinsurance agreement have reduced the net loss and LAE ratio by
approximately 11 percentage points.
o The remainder of the difference is due to the lower direct reserves that
were established on the 1999 accident year.
Underwriting Expenses:
Underwriting expenses consist of policy acquisition costs and other
underwriting costs. Policy acquisition costs are those expenses that are
directly related to, and vary with, written premiums. Examples of policy
acquisition costs are commissions and allowances paid to agents and brokers,
premium taxes, boards and bureau fees and certain operating expenses primarily
related to underwriting and marketing departments. Policy acquisition costs
decreased by $12.9 million or 67% for the year ended December 31, 1999 compared
to 1998. The decrease was all due to a ceding commission of $14.7 million
received on the low level reinsurance agreement as a partial reimbursement of
our expenses. Partially offsetting the ceding commissions were higher
commissions paid to agents and brokers in order to remain competitive in the
market place. Other underwriting expenses increased by $.6 million in 1999
compared to 1998 due to higher personnel costs to service the increase in
premium growth. As a percentage of net earned premiums, the underwriting expense
ratio was 31.5% in 1999 compared to 28.4% in 1998. The improvement in the
expense ratio was largely due to the ceding commissions.
General, Administrative and Other Expenses:
The increase in this income statement line item was primarily due to other
underwriting expenses of $19.6 million for the year ended December 31, 1999
compared to $19.0 million for 1998.
Combined Ratio:
The combined ratio is a measurement of underwriting profit or loss and is
the sum of the loss and LAE ratio, underwriting expense ratio and policyholders'
dividend ratio. A combined ratio of less than 100% indicates an underwriting
profit. Our combined ratio was 105.5% for the year ended December 31, 1999
compared to 98.7% for 1998. The increase was due to a higher loss and LAE ratio
of 3.8 percentage points and a higher underwriting expense ratio of 3.1
percentage points. The increase in the 1999 year loss and LAE ratio was
primarily due to net adverse loss development of $9.9 million, which represents
11.9% of 1999 net earned premiums, whereas the 1998 year had favorable loss
development of $9.6 million, which represented 7.1% of 1998 net earned premiums.
The change in loss development was partially offset by additional amounts of
ceded losses and LAE under the low level reinsurance agreement. The increase in
the underwriting expense ratio was primarily due to the lower net earned premium
base in 1999.
Income Taxes:
For the year ended December 31, 1999, we recorded a tax provision of $3.6
million compared to a tax provision of $4.2 million in 1998. The effective tax
rate was 50% for 1999 compared to 23% for 1998. The increase in the effective
tax rate for 1999 was due to the fact that all of the California Indemnity net
operating losses, or NOLs, which had been fully reserved were utilized during
1998 and the accompanying valuation allowances were reversed. As a result of
these valuation allowance reversals the tax expense and effective tax rate were
reduced in 1998. On a separate return basis, CII Financial has historically
recorded NOLs, including the three years ended December 31, 1999 for which
valuation allowances have been recorded due to CII Financial's inability to
generate significant earnings on its own.
Results of Operations for the Year Ended December 31, 1998 Compared to the Year
Ended December 31, 1997
Our income before taxes increased by $7.1 million for the year ended
December 31, 1998 compared to 1997. The major components of the change were:
o $5.1 million increase in net earned premiums; o $1.5 million increase in
investment income; o $1.4 million increase in net realized gains; and o
$1.0 million increase in loss and loss adjustment expenses.
Revenues:
Our revenue is comprised of net earned premiums, net investment income and
net realized gains/losses. Total revenue increased by $7.9 million or 5% for the
year ended December 31, 1998 compared to 1997. The increase was largely due to
higher net earned premiums of $5.1 million.
Net earned premiums are the end result of direct written premiums, plus the
change in unearned premiums, less premiums ceded to reinsurers. Our direct
written premiums increased by $18.3 million or14% due primarily to increased
premium growth in California. Ceded reinsurance premiums also increased by $14.8
million and were primarily due to the low level reinsurance agreement, which is
discussed below.
The following table shows a comparison of direct written premiums, by
state, for the year ended December 31, 1998 and 1997:
Year Ended December 31,
1998 % of total 1997 % of total
(dollars in millions)
California $129.3 84.0% $113.1 83.4%
Colorado 12.0 7.8 12.8 9.4
Texas 8.1 5.3 6.3 4.6
Other States 4.5 2.9 3.4 2.6
Total $153.9 100.0% $135.6 100.0%
==============================================================================
Our largest premium state, California, had the largest increase in written
premiums due in large part to premium growth from writing more policies that
occurred in the first half of 1998. The market-pricing environment in California
became less favorable at the end of 1998 due to some competitors using
reinsurance as a way of reducing premium rates to gain market share.
Premiums in force are an indicator of future written premium trends.
Inforce premiums are the total estimated annual premiums of all policies in
force at a point in time. Although total inforce premiums at December 31, 1998
increased by 3% to $132.8 million from December 31, 1997, there was a downward
trend in the last half of 1998. Total inforce premiums increased in the first
half of 1998 from $128.8 million at January 1, 1998 to a high of $142.8 million
in July 1998 and declined in the last half of 1998 due to escalating price
competition in California.
Effective July 1, 1998, we entered into what we refer to as a "low level"
reinsurance agreement. See Losses and Loss Adjustment Expenses below for further
details on this agreement. The favorable terms of the low level reinsurance
agreement provided us with an improved loss ratio as we reinsured a significant
amount of losses to the reinsurer. However, the ceded premiums we paid the
reinsurer reduced the cash available for investment and temporarily created
negative cash flow for us. Our first payment to the reinsurer was not made until
the end of December 1998. Thus, the timing of this payment did not reduce our
net investment income in 1998 the increase in our investment income was related
to the increase in our investment portfolio throughout most of 1998.
In 1998, we had net realized gains of $2.0 million for the year ended
December 31, 1998 compared to net realized gains of $.6 million in 1997. We try
to manage our investment portfolio to minimize unplanned sales of our
available-for-sale investments. In 1998 and 1997, we sold some of our
investments in debt securities and realized some gains.
Losses and Loss Adjustment Expenses:
The $1.0 million net increase in the losses and LAE was primarily
attributable to premium growth, which increased losses and LAE by $16.2 million.
This increase was substantially reduced by the effects of the low level
reinsurance agreement which reduced the dollar amount of losses and LAE in 1998
by approximately $21.0 million. Changes in excess reinsurance resulted in an
increase in losses and LAE of $5.9 million.
Under our low level reinsurance agreement, we reinsure 30% of the first
$10,000 of each claim, 75% of the next $40,000 and 100% of the next $450,000.
The maximum net loss retained on any one claim ceded under this agreement is
$17,000. This agreement covered all policies in force at July 1, 1998. We also
had excess of loss reinsurance agreements that covered 100% of the losses above
$500,000 to $100 million.
As a percentage of net earned premiums, the loss and LAE ratio for year
ended December 31, 1998 was 70.3% compared to 72.2% for 1997. The reduction was
primarily due to the effects of the low level reinsurance agreement. In
addition, we also had net favorable loss development on prior accident years of
$9.6 million compared to net favorable loss development of $9.0 million in 1997.
The net favorable loss developments were primarily attributable to lower than
expected loss and LAE payments.
Underwriting Expenses:
Underwriting expenses consist of policy acquisition costs and other
underwriting costs. Policy acquisition costs are those expenses that are
directly related to, and vary with, written premiums. Examples of policy
acquisition costs are commissions and allowances paid to agents and brokers,
premium taxes, boards and bureau fees and certain operating expenses primarily
related to underwriting and marketing departments. Policy acquisition costs
decreased by $.6 million. The increase in policy acquisition costs that would
normally accompany an increase in related premium revenues was substantially
offset by a ceding commission of approximately $3.9 million. We received a
ceding commission on the low level reinsurance agreement as a partial
reimbursement of our expenses. Other underwriting expenses increased by $0.5
million or 3% for the year ended December 31, 1998 compared to 1997. As a
percentage of net earned premiums, the underwriting expense ratio was 28.4% in
1998 compared to 29.7% in 1997. The decrease in the expense ratio was largely
due to the ceding commission received on the low level reinsurance agreement.
General, Administrative and Other Expenses:
The increase in this income statement line item was primarily due to other
underwriting expenses of $19.0 million for the year ended December 31, 1998
compared to $18.5 million for 1997.
Combined Ratio:
The combined ratio is a measurement of underwriting profit or loss and is
the sum of the loss and LAE ratio, underwriting expense ratio and policyholders'
dividend ratio. A combined ratio of less than 100% indicates an underwriting
profit. Our combined ratio was 98.7% for the year ended December 31, 1998
compared to 101.9% for 1997. The decrease was primarily due to a lower loss and
LAE ratio of 2.0 percentage points and a lower underwriting expense ratio of 1.2
percentage points. The decrease in the 1998 year loss and LAE ratio was
primarily due to the low level reinsurance agreement and net favorable loss
development of $9.6 million, which represents 7.1% of 1998 net earned premiums.
The 1997 year had net favorable loss development of $9.0 million, which
represented 7.0% of 1997 net earned premiums. The decrease in the underwriting
expense ratio was primarily due to the ceding commission received on the low
level reinsurance agreement of $3.9 million.
Income Taxes:
For the year ended December 31, 1998, we recorded a tax provision of $4.2
million compared to a tax provision of $0.3 million in 1997. The effective tax
rate was 23% for 1998 compared to 2% for 1997. Both the 1998 and 1997 effective
tax rates were less than the statutory rate primarily due to reductions in the
deferred income tax valuation allowance from the use of net operating loss
carryforwards of California Indemnity.
Liquidity and Capital Resources
Our insurance subsidiaries require liquidity to pay policy claims and
benefits, for operating expenses, income taxes and to purchase fixed assets to
maintain and enhance their operations. The source of our insurance subsidiaries'
funds come from the premiums we collect, the investment income we earn and
receipts from our reinsurers. The liquidity needs of our non-insurance
operations, which are essentially the holding company, CII Financial, are
substantially all related to the servicing of interest payments on the old
junior subordinated debentures and, eventually, the payment of these debentures
at maturity.
Our insurance subsidiaries are required to maintain sufficient liquid
assets to pay claims and other policy obligations. Workers' compensation
insurance is referred to as "long-tail" business because of the length of time
that typically occurs between when the premium is collected and when a claim is
fully paid and settled due to life-time benefits that could be provided to a
claimant. The excess of premiums collected over claims and expenses paid are
invested until needed. State regulations dictate the kinds of investments we can
have and we try to match the maturity of our investments with expected future
cash needs.
Our only significant short-term non-insurance liquidity need is the
repayment of the $47 million in old junior subordinated debentures, which are
due on September 15, 2001, and is discussed further below. If our proposed
exchange offer for the old junior subordinated debentures is successful and we
issue new senior subordinated debentures with a maturity date of September 15,
2006, then our long-term non-insurance liquidity needs will be to service this
new debt. We expect to service this new debt from future cash flows, primarily
from dividends that will be paid by our insurance subsidiaries from their future
earnings.
We had negative cash flows from operating activities of $2.3 million for
the nine months ended September 30, 2000 and $29.5 million for the year ended
December 31, 1999. Our negative cash flow for the 2000 period was largely due to
a net loss of $8.5 million and an increase in reinsurance recoverable on paid
and unpaid losses of $79.7 million, which were partially offset by an increase
in loss and LAE reserves of $97.5 million. Our negative cash flow for the 1999
year was primarily due to a net increase in reinsurance recoverable on paid and
unpaid losses of $73.4 million offset by an increase in loss and LAE reserves of
$32.1 million, an increase in deferred income taxes of $5.9 million and net
income of $3.6 million. The increases in reinsurance recoverable were primarily
due to the low level reinsurance agreement. The increases in the loss and LAE
reserves were due to premium growth as well as adjustments related to net
adverse development on prior accident years recorded in 2000 of $20.2 million
and $9.9 million in 1999.
Our net cash provided by investing activities was $9.9 million for the nine
month 2000 period and $24.8 million for the year ended 1999. Capital
expenditures in 2000 were $0.8 million and $4.2 million in the year ended 1999.
Our insurance subsidiaries anticipate their capital expenditures to approximate
$2 to $4 million per year over the next several years. Due to the negative cash
flows from operations, we had to sell some of our investments.
Our net cash flows from financing activities were a negative $5.1 million
for the nine month 2000 period and negative $0.6 million for the year 1999. The
negative cash flows from financing activities for both periods were a result of
our repurchase of old junior subordinated debentures in the open market.
In September 1991, CII Financial, the holding company, issued the old
junior subordinated debentures. The old junior subordinated debentures bear
interest at 7 1/2% per annum, which is due semi-annually on March 15 and
September 15. Each $1,000 in principal is convertible into 25.382 shares of
common stock of our ultimate parent company, Sierra Health Services, at a
conversion price of $39.398 per share. The old junior subordinated debentures
have no financial ratio covenants. The primary covenants include the timely
payment of principal, premium, interest and taxes. Other covenants include our
agreement to maintain our existence, business properties and an office where the
old junior subordinated debentures can be surrendered for payment, transfer or
conversion. There are also covenants regarding our offering to purchase the old
junior subordinated debentures upon specified non-approved mergers and changes
in control. Since Sierra's acquisition of us was approved by our board of
directors and our shareholders, we were not required to offer to purchase the
old junior subordinated debentures. The new senior subordinated debentures will
have covenants similar to the old junior subordinated debentures. Unamortized
issuance costs of $362,000 are included in other assets on the balance sheet and
are being amortized over the life of the old junior subordinated debentures. The
old junior subordinated debentures are junior subordinated obligations of CII
Financial only and are not guaranteed by Sierra.
Sierra has a bank credit facility with outstanding borrowings of $185
million at September 30, 2000. Sierra was in breach of its financial
covenants (leverage ratio, consolidated net worth and fixed charges coverage
ratio) at June 30, 2000. In consideration of the banks granting a waiver of
compliance, in August 2000, CII Financial became a guarantor of the Sierra
credit facility debt. The guaranty of the bank debt ranks senior to the old
junior subordinated debentures. The waivers expired on October 31, 2000 and
Sierra received a notice of default from the banks on November 8, 2000. The
credit facility was amended and restated on December 15, 2000.
The new credit agreement currently provides Sierra with a revolving credit
facility of $135 million. The available amounts, which Sierra can borrow under
the credit facility, will be reduced by amounts ranging from $2.0 million to
$10.0 million every six months starting in June 2001. This may necessitate a
loan paydown of the amount of outstanding loans in excess of the reduced
commitments, if any. In addition, under certain circumstances, Sierra would be
required to make prepayments of the loans, and the amount available to Sierra
under the revolving credit facility would be reduced. For example, 80% of any
excess cash flow that Sierra has in each year must be applied to a repayment of
the credit facility. In addition, if Sierra or a subsidiary of Sierra (other
than a regulated subsidiary and other specified subsidiaries) engages in an
asset sale or a sale-leaseback transaction (with the exception of specified
assets in the new credit agreement), 80% of the net cash proceeds must be
applied to a repayment of the loans and a reduction of the amount available
under the revolving credit facility. In addition, 100% of the net cash proceeds
of a debt issuance (excluding issuances by CII Financial) must be applied to a
repayment of the loans and a reduction in the amount available under the
revolving credit facility. Subject to normal qualifications and exceptions,
Sierra has covenants that, among other things, will restrict the ability of
Sierra and its subsidiaries, including CII Financial, to dispose of assets,
incur indebtedness, pay dividends, make investments, loans or advances, make
acquisitions, engage in mergers or consolidations, or make capital expenditures
and which otherwise restrict certain corporate activities. In addition, Sierra
is required to comply with specified financial ratios, as defined in the new
credit agreement, including minimum interest coverage ratios and leverage
ratios. Since December 15, 2000, Sierra has been in compliance with the
financial covenants of the new credit agreement.
CII Financial is a holding company and its only significant assets are its
investment in California Indemnity Insurance Company. Of the cash and cash
equivalents held at September 30, 2000, approximately $231 million were
designated for use only by the regulated insurance companies.
CII Financial has limited sources of cash and is dependent upon dividends
paid by California Indemnity. The payment of stockholders' dividends by
California Indemnity is regulated by the California Insurance Code and, at a
minimum, requires a 10 work day prior notice to the California Department of
Insurance. If a payment of a dividend or distribution whose fair market value,
together with that of other dividends or distributions made within the preceding
12 months, exceeds the greater of ten percent of the insurer's surplus or its
net income for the preceding year end, then the insurance commissioner has up to
30 days to disapprove it. The California Insurance Department will not allow a
payment of a dividend or distribution if it will cause an insurer's
policyholders' surplus to be unreasonable in relation to the insurer's
liabilities and the adequacy of the insurer's financial needs. In making this
determination, the Department of Insurance considers a variety of factors
including, but not limited to, the size of the insurer, the amount, type and
geographic concentration of insurance it writes, the quality of its assets and
reinsurance programs, and operating trends.
In addition, California law provides that an insurer may not pay a dividend
without the prior approval of the state insurance commissioner to the extent the
cumulative amount of dividends or distributions paid or proposed to be paid in
any year exceeds the amount shown as unassigned funds (reduced by any unrealized
gains included in such amount) on the insurer's statutory statement as of the
previous December 31. As of September 30, 2000, California Indemnity Insurance
Company, which is our only direct insurance subsidiary, did not have any
unassigned funds from which it could pay a dividend without prior approval.
California Indemnity Insurance Company declared and paid no dividends to
CII Financial in 1998 but paid $6.0 million of dividends to it in 1999 and $6.7
million in 2000.
Sierra advanced $365,000 to us in order to enable us to make our September
15, 2001 interest payment on the old junior subordinated debentures. Sierra's
amended and restated bank credit facility will limit Sierra's ability to make
any future advances to us. Since we do not believe that we will have sufficient
sources of cash to pay the maturing old junior subordinated debentures, we are
proposing to exchange the old junior subordinated debentures for a combination
of cash and/or new senior subordinated debentures. The sources for the cash
portion of the proposed exchange offer are dependent upon our receiving approval
from the California Department of Insurance to allow California Indemnity
Insurance Company to pay a dividend to CII Financial and upon loans from Sierra
and/or other affiliates. However, these types of loans are limited by Sierra's
credit facility. In addition, in order to issue the new senior subordinated
debentures in the proposed exchange offer, we will need the consent of a
two-thirds majority in principal amount of the lenders under Sierra's credit
facility.
If the proposed exchange offer is unsuccessful and we were to default on
the payment of the old junior subordinated debentures when they mature, then
there will be a cross default on Sierra's credit facility debt and the banks may
demand that CII Financial perform on its payment guaranty. If we then had to
sell our insurance subsidiaries, our net cash proceeds would probably be
substantially less than if the sale were to occur when we were not in a default
situation. Under such circumstances, the California Department of Insurance
could, among other things, exercise its oversight powers to preserve the assets
of the insurance companies for the benefit of the policyholders and claimants
and could prevent or significantly delay a possible sale of our insurance
subsidiaries.
Since our acquisition by Sierra in October 1995, we have paid dividends to
Sierra totaling $2.6 million. Since the acquisition, Sierra has contributed $3.7
million to us by purchasing in the open market old junior subordinated
debentures and contributing them to us for retirement.
Inflation
Inflation can be expected to affect our operating performance and financial
condition in several aspects. Inflation can reduce the market value of our
investment portfolio; however, we try to manage our investment portfolio to
minimize unplanned sales. Inflation can adversely affect the portion of loss and
LAE reserves that relate to hospital and medical expenses, although some medical
expenses are established by statute. Loss reserves related to indemnity benefits
for lost wages are not directly affected by inflation as these amounts are
established by statute. We do not believe that inflation has had a material
effect on our results of operations.
Recent Accounting Pronouncements
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"). SAB 101 clarifies existing accounting principles related to revenue
recognition in financial statements. We are required to comply with the
provisions of SAB 101 in the quarter ending December 31, 2000. Based upon the
current nature of our operations, we do not believe that SAB 101 will have any
impact on our results of operations.
In June 1998, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), as amended, which is effective
for fiscal years beginning after June 15, 2000. SFAS 133 establishes additional
accounting and reporting standards for derivative instruments and hedging
activities. SFAS 133 requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position. This statement
also defines and allows companies to apply hedge accounting to its designated
derivatives under certain instances. It also requires that all derivatives be
marked to market on an ongoing basis. This applies whether the derivatives are
stand-alone instruments, such as warrants or interest rate swaps, or embedded
derivatives, such as call options contained in convertible debt investments.
Along with derivatives, in the case of qualifying hedges, the underlying hedge
items are also to be marked to market. These market value adjustments are to be
included either in the income statement or other comprehensive income, depending
on the nature of the hedged transaction. The fair value of financial instruments
is generally determined by reference to market values resulting from trading on
a national securities exchange or in an over the counter market. In cases where
derivatives relate to financial instruments of non-public companies, or where
quoted market prices are otherwise not available, such as for derivative
financial instruments, fair value is based on estimates using present value or
other valuation techniques. Based on our understanding of SFAS 133, we do not
believe that we have any derivative instruments and do not have any hedging
activities. The majority of our investments are held by our insurance
subsidiaries, which are regulated as to the types of investments they may hold.
Quantitative and Qualitative Disclosures About Market Risk
At December 31, 1999, we had $217.1 million in cash, cash equivalents and
invested assets of which $215.5 million is designated for use only by our
regulated insurance subsidiaries. Our invested assets consist of debt securities
of $190.3 million, of which $165.3 million were classified as available-for-sale
and $25.0 million was classified as held-to-maturity. These investments are
substantially investment grade securities. Our investment policies emphasize
return of principal and liquidity and are focused on fixed returns that limit
volatility and risk of principal. Our primary market risk associated with our
investment portfolio is interest rate risk.
Assuming interest rates were to increase by a factor of 1.1, the net
hypothetical loss in fair value of shareholder's equity related to financial
instruments would approximately be $6.1 million after tax. This would represent
approximately 9% of shareholder's equity. We believe that if interest rates were
to increase by this amount, it would not have a material impact on our future
earnings or cash flows as it is unlikely that we would need or choose to
substantially liquidate our investment portfolio.
At September 30, 2000, we had $214.2 million in cash, cash equivalents and
invested assets of which $213.4 million is designated for use only
by our regulated
insurance subsidiaries. Our invested assets consisted of debt securities of
$186.8 million, of which $164.7 million were classified as available-for-sale
and $22.1 million were classified as held-to-maturity. The composition of our
investments and our investment policies have not materially changed when
compared to December 31, 1999. We believe that if interest rates were to
increase as described above, it would not have a material impact on our future
earnings or cash flows as it is unlikely that we would need or choose to
substantially liquidate our investment portfolio.
The effect of interest rate risk on potential near-term net income, cash
flow and fair value was determined based on commonly used sensitivity analyses.
The models project the impact of interest rate changes on a wide range of
factors, including duration and prepayment. Fair value was estimated based on
the net present value of cash flows or duration estimates, assuming an immediate
10% increase in interest rates.
MANAGEMENT
Directors and Executive Officers
The following table sets forth information concerning our directors and
executive officers.
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Name Position Age
- -----------------------------------------------------------------------------
Paul H. Palmer Director 39
Frank E. Collins Director 46
Kathleen M. Marlon President, Chief Executive Officer, Chairman and Director 42
John F. Okita Chief Financial Officer 52
Robert G. Riordan Vice President, Region II 48
Robert L. Selli Vice President, Region I 59
David M. Sonenstein General Counsel and Secretary 53
- -------------------------------------------------------------------------------
Paul H. Palmer, Director. Mr. Palmer is the vice president of finance,
chief financial officer and treasurer of Sierra. He was promoted to these
offices in 1998. Prior to this, he was assistant vice president of Sierra from
May 1996, corporate controller from November 1994 and director of finance when
he joined Sierra in 1993. Prior to joining Sierra, Mr. Palmer was an audit
manager at Deloitte & Touche LLP (formerly Touche Ross) in Las Vegas and
California from 1988 to 1993. Mr. Palmer is a certified public accountant with
an MBA and masters in accounting from Brigham Young University. He is a member
of the American Institute of Certified Public Accountants, the Nevada State
Society of Certified Public Accountants and the California State Society of
Certified Public Accountants.
Frank E. Collins, Director. Mr. Collins joined Sierra in 1986 as general
counsel and secretary. In 1997 he was appointed executive vice president. From
1981 to 1986, Mr. Collins was employed by Blue Cross and Blue Shield of Kansas
City, originally as staff legal counsel and in early 1986 as associate general
counsel. Mr. Collins also served as counsel for the Missouri Division of
Insurance from 1979 to 1981, where he was responsible for providing legal advice
on insurance- and HMO-related regulatory issues. Mr. Collins received his Juris
Doctorate in 1979 from the University of Missouri at Kansas City
school of law and
is a member of the Missouri Bar Association.
Kathleen M. Marlon, President, Chief Executive Officer, Chairman and
Director. Ms. Marlon joined Sierra in March 1986. In 1990, she became president
and chief operating officer of Sierra Healthcare Options, Inc., a start-up
subsidiary of Sierra. In February 1996, Ms. Marlon became our president and
chief executive officer. In December 2000, Ms. Marlon became our chairman. Prior
to joining Sierra, Ms. Marlon held technical and management positions for six
years with Delphi Systems and Quality Systems. Ms. Marlon received her Bachelor
of Science in Accounting from the University of Southern California in 1980. Ms.
Marlon has successfully completed the CPA exam and Property & Casualty and
Health licensing exams and holds a F.L.M.I. designation. Ms. Marlon is married
to Anthony M. Marlon's nephew. Anthony M. Marlon is the chairman and chief
executive officer of Sierra.
John F. Okita, Chief Financial Officer. Mr. Okita has served in this
capacity since he started his employment with us in April 1992 until September
1999 and from June 2000 to present. In September 1999, Mr. Okita left us to
become the corporate controller of Sierra, a position he still holds. In June
2000 he returned to us as our chief financial officer. Mr. Okita is a certified
public accountant and a licensed attorney and has over twenty years of
property-casualty insurance industry experience. Prior to joining us, Mr. Okita
was in private tax and financial consulting practice. Mr. Okita served in
several financial executive capacities at Fremont Insurance Group between 1980
and 1990. Prior to that, Mr. Okita was employed by Coopers & Lybrand from 1975
and audited both property-casualty and life insurance companies. Mr. Okita
received his Bachelor of Science in Business Administration from California
State University at Los Angeles and his Juris Doctorate from Loyola Law School.
Robert G. Riordan, Senior Vice President, Field Operations. Mr. Riordan was
promoted to this position in May 1997 after having served as director of field
operations since November 1993. He was vice president of Northern California
operations for USA Casualty Company from November 1991 until joining Sierra in
1993. Prior to USA Casualty, Mr. Riordan had held various underwriting,
marketing and financial reporting positions with Fireman's Fund Insurance
Companies since 1976. Mr. Riordan attended Steubenville College where he
received a Bachelor of Science degree in Business Administration.
Robert L. Selli, Vice President, Underwriting. Mr. Selli was promoted in
November 1997 after serving as director of underwriting since December 1996. Mr.
Selli has served as Northern California Underwriting Manager and key member of
our California Open Rating Task Force since he joined us in January 1994. Prior
to that time, Mr. Selli held various underwriting management and marketing
positions with Fireman's Fund Insurance Company and Zurich American since
entering the industry in 1967. Mr. Selli attended San Francisco State University
where he received a Bachelor of Arts degree in economics.
David M. Sonenstein, General Counsel and Secretary. Mr. Sonenstein has
served as general counsel since joining us in August 1997 and as secretary since
early 1999. Mr. Sonenstein served as vice president and associate general
counsel of Fireman's Fund Insurance Company, from 1991 to 1997. He started his
employment with Fireman's Fund as Associate Counsel in 1979. Mr. Sonenstein was
in private practice from 1972 to 1979. Mr. Sonenstein graduated from Claremont
Men's College with a Bachelor of Arts degree and received his Juris Doctorate
in 1972 from Hastings College of Law.
Executive Compensation
The following table sets forth information with respect to the compensation
paid by us for the year ended December 31, 1999 to our chief executive officer
and to each of our four next most highly compensated executive officers:
SUMMARY COMPENSATION TABLE
Name of Individual
Or Number Of Persons In Capacities in Cash Compensation All Other
----------- ------------
Group Which Served Bonus Compensation
Kathleen M. Marlon President, Chief $214,291 $78,733 $25,457 (1)
Executive Officer
Richard E. Dobson Chief Legal Officer 225,715 47,800 13,115
John F. Okita Chief Financial 126,912 66,698 21,487
Officer
Robert G. Riordan Senior Vice 139,445 30,047 10,907
President, Field
Operations
David M. Sonenstein General Counsel 124,214 27,583 13,342
- --------------
(1) Includes $15,451 of compensation resulting from split-dollar insurance
policies purchased in 1997, calculated based on regulations of the SEC. The
regulations require compensation to be calculated on the assumption that most of
the premiums paid by us represent a long-term, no-interest loan to the
executive. This assumption results in high compensation expense being shown in
early years of the expected life of each policy and lower expense in later
years, while in fact the cash surrender value of such a policy to the executive
is very low in the early years and higher only in the late years.
Compensation of Directors
The directors are our employees or employees of Sierra and receive no
additional compensation for their service on our board.
Employment Agreements
Our subsidiary, California Indemnity Insurance Company, has entered
into a three-year employment agreement with Kathleen M. Marlon, its chief
executive officer. Under the agreement, Ms. Marlon may voluntarily terminate
employment upon 60 days' notice. California Indemnity may terminate her
employment, with or without cause, in accordance with California Indemnity's
usual policies and procedures. The employment agreement provides that, in the
event of a termination by California Indemnity without cause, a severance
payment will be paid in the amount of 12 months' salary to Ms. Marlon. The
agreement also provides that, a disability must continue for at least six months
before California Indemnity may terminate her employment. In the event of a
change in control not approved by the board of directors of California
Indemnity, or if a change in control is approved by the board but within two
years thereafter Ms. Marlon is terminated without cause, demoted, provided
reduced compensation or required to relocate, Ms. Marlon will be entitled to
receive a payment equal to a multiple of two times her salary and target annual
incentive. In addition, if "golden parachute" excise taxes apply to compensation
paid by California Indemnity, California Indemnity will provide a gross-up
payment sufficient to cause the after-tax value of the compensation and the
gross-up payment to Ms. Marlon to be the same as if no such excise had applied.
The employment agreement contemplates annual adjustments in compensation based
on job duties, performance goals and objectives and other reasonable standards
deemed appropriate by California Indemnity. The agreement restricts Ms. Marlon's
use and disclosure of confidential information, interference with California
Indemnity's business relationships, and competition with California Indemnity,
including a prohibition, for a one-year period following any termination of
employment, on her working for a competitor which operates in California,
Nevada, or Texas.
Stock Options
Our executive officers participate in Sierra's stock option plan. The
following table contains information concerning the grants by Sierra of stock
options to acquire Sierra common stock to the named executives during fiscal
year 1999:
OPTION/SAR GRANTS IN FISCAL YEAR 1999
Individual Grants (1)
Number of % of Total -------------- Potential Realizable
Securities Options/SARs Value at Assumed
Underlying Granted to Exercise or Annual Rates of Stock
Options/SARs Employees in Base Price Expiration Price Appreciation for
Granted (#) 1999 ($/Share) Date Option Terms
5% ($) 10% ($)
Kathleen M. Marlon 75,000 (2)(3) 47% 8.00 10/12/05 $204,057 $462,937
Richard E. Dobson -0- N/A N/A N/A N/A N/A
John F. Okita 10,000 (2)(3) 6% 8.00 10/12/05 27,208 61,725
Robert G. Riordan 7,500 (3)(4) 5% 6.6875 12/30/05 31,543 79,936
David M. Sonenstein 7,500 (3)(4) 5% 6.6875 12/30/05 31,543 79,936
- -------------
- ------------------------------------------------------------------------------
(1) All options were granted at an exercise price equal to the fair market
value of Sierra common stock on the option grant date. The exercise price
may be paid by the optionee in cash or by check, except that Sierra's stock
plan committee may, in its discretion, allow such payment to be by
surrender of unrestricted shares of Sierra common stock (at their fair
market value on the date of exercise), or by a combination of cash, check
and unrestricted shares.
(2) These options were granted on October 13, 1999 and vest and are exercisable
at the rate of 20% per year starting with the first anniversary date of the
grant and will expire not later than six years after grant.
(3) All awards were non-qualified stock options granted pursuant to Sierra's
1995 long-term incentive plan. No stock appreciation rights were granted
with the above awards. Upon a change of control of Sierra, as defined in
the 1995 Plan, the vesting of the options will be automatically
accelerated, provided, however, that Sierra's stock plan committee may
exclude a change of control transaction from the foregoing provisions and
permit the option to continue to vest in accordance with its original
terms. In addition, the options shown above will terminate and may no
longer be exercised if the respective optionee ceases to be an employee or
director of Sierra or one of its affiliates, except certain
post-termination exercise periods are permitted in the case of death,
disability, or other involuntary termination except for a termination for
"cause." The options together with certain gains realized upon exercise of
the options during a specified period will be subject to forfeiture if the
optionee engages in certain acts in competition with Sierra or one of its
affiliates, misuses proprietary information of Sierra or one of its
affiliates, or fails to assist Sierra or one of its affiliates in
litigation. Cashless withholding to satisfy tax obligations may be
permitted by Sierra's stock plan committee.
(4) These options were granted on December 31, 1999 and vest and are
exercisable at the rate of 20% per year starting with the first anniversary
date of the grant and will expire not later than six years after grant.
Option Exercises and Holdings
The following table provides information with respect to the named
executives concerning the exercise of Sierra stock options during the fiscal
year ended December 31, 1999 and unexercised Sierra stock options held as of
December 31, 1999:
Aggregated Option/SAR Exercises in Fiscal 1999 and Year-End Option Values
------------------ Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/SARs at Options/SARs at
Shares FY-End (#) FY-End ($)
Acquired on Value Exercisable/ Exercisable/
Exercise (#) Realized ($) Unexercisable Unexercisable (1)
Kathleen M. Marlon -0- -0- 46,963 / 105,537 -0- / -0-
Richard E. Dobson (2) -0- -0- 36,825 / 5,675 -0- / -0-
John F. Okita -0- -0- 43,215 / 15,625 -0- / -0-
Robert G. Riordan -0- -0- 11,671 / 21,234 -0- / -0-
David M. Sonenstein -0- -0- 1,700 / 10,550 -0- / -0-
- --------------
(1) Based on the closing price of Sierra common stock on December 31, 1999,
which was $6.6875, minus the exercise price of the option.
(2) Mr. Dobson's right to acquire stock pursuant to his options terminated on
August 28, 2000.
CII Financial's Supplemental Executive Retirement Plans
Certain of our executive officers were participants in the CII Financial,
Inc. Supplemental Executive Retirement Plan, or the SERP Plan, and the CII
Financial, Inc. Supplemental Senior Executive Retirement Plan, or the Senior
SERP Plan. These plans were effective as of January 1, 1990 and the SERP Plan
was amended and restated April 24, 1993. When we were acquired by Sierra in
October 1995, both plans were frozen as to any new contributions, participants,
and accrued benefits. The Senior SERP Plan had only one participant, Mr. Joseph
G. Havlick, who at that time was our chief executive officer. Of the eight
participants in the SERP Plan, only Mr. Okita remains an officer of CII
Financial.
Our Board of Directors appoints a committee to administer both plans.
Participation in both plans was limited to the executives, officers and
employees selected by our chief executive officer and approved by our board of
directors. The criteria used to determine participation in either plan was the
participant's position, past contributions and anticipated contributions to our
future success.
The committee determined the benefit amount that would be paid at the
participant's normal retirement age. The initial benefit amount was
discretionary and was adjusted based on the participant's employment service
years from the date of participation. Participants were given credit for
employment prior to the plans' effective date of January 1, 1990. Under the SERP
Plan, the benefit amount was also adjusted based on whether a participant
retired at, prior to, or after, normal retirement age. Benefit amounts under
both plans are paid in equal monthly installments over a 10-year period. Both
plans also provide for a benefit payable over a 10-year period if a participant
dies while still employed by us. Mr. Okita's annual benefits under the SERP Plan
are $300.
Sierra's Supplemental Executive Retirement Plan
Ms. Kathleen Marlon participates in Sierra's Supplemental Executive
Retirement Plan II (the "Supplemental Plan II"), which provides retirement
benefits for selected executive officers. Under the Supplemental Plan II, each
executive selected for participation generally will be entitled to receive
annual payments, following retirement, disability, and certain other
terminations of employment, for a 15-year period, equal to 2.5% of their "final
average compensation" (as defined) for each year of service credited to the
executive up to 20 years, reduced by an amount equal to the annualized payout
over a 15-year period that would be payable to the executive as a result of
Company contributions under the 401(k) Plan and the Deferred Compensation Plan
(but not reduced for social security payments or other offsets). An executive's
right to benefits under the Supplemental Plan II vests when five years of
service have been credited or earlier upon the executive's death or disability
or upon occurrence of a change in control (defined in the same way as under
other compensatory plans). Upon the death of the executive, benefits will be
payable for the 15-year period to the executive's beneficiary. Benefits will
begin after retirement at or after age 65, a termination at or after age 55 and
ten years of credited service, or a termination due to disability, and benefits
will begin, in the case of other terminations (except a termination for "cause,"
as defined) prior to a change in control, at the later of termination or the
date the executive would have completed ten years of service but for the
termination.
The following table shows the approximate amounts of annual retirement
income that would be payable under the Supplemental Plan II to executives
covered by it based on various assumptions as to final average compensation and
years of service, assuming benefits are paid out over 15 years:
Estimated Annual Benefits Based on Credited Years of Service
Final Average
Compensation ---------------
------------
5 Years 10 Years 15 Years 20 Years 30 Years
------- -------- -------- -------- --------
$200,000 $23,366 $46,732 $70,099 $92,465 $93,465
400,000 45,225 90,450 135,675 180,900 180,900
600,000 67,837 135,675 203,512 271,350 271,350
- -------------------------------------------------------------------------------
Final average compensation generally means the average of the three
highest years of compensation out of the last five years, with compensation
being generally the amounts reported as salary and bonus in the Summary
Compensation Table.
Ms. Marlon has 14 years of credited service under the Supplemental Plan
II. An additional year of service will be credited in the event of a termination
within six years after a change in control, and the year of service for the year
of the change in control will be deemed completed at the time of the change in
control. An executive's or beneficiary's benefits are payable in a lump sum in
certain circumstances, including following a change in control.
No other executives of CII Financial participate in Sierra's
Supplemental Executive Retirement Plan II.
CERTAIN TRANSACTIONS
We intend to finance all or a portion of the cash consideration in the
exchange offer, together with interest and expenses, with a loan from one of our
affiliates. We will not be able to determine the amount of cash needed until the
expiration of the exchange offer. Our affiliates have no obligation to advance
these funds to us. However, in the event the loan is made, the indebtedness will
be represented by a demand promissory note issued to the affiliate bearing
interest at a rate equal to the then current interest rate on Sierra's credit
facility. This affiliate note will rank senior to both the old junior
subordinated debentures and the new senior subordinated debentures.
In August 2000, we, and some other subsidiaries of Sierra, became a
guarantor of Sierra's obligations under its senior secured credit facility. For
more information concerning this guaranty, see "Description of Other
Indebtedness."
In order to make the September 15, 2000 interest payment on the old junior
subordinated debentures, Sierra advanced $365,000 to us.
Effective January 1, 1999, Sierra entered into separate but similar
investment services agreements with California Indemnity Insurance Company,
Commercial Casualty Insurance Company, Sierra Insurance Company of Texas and CII
Insurance Company. Under these agreements Sierra manages the investments of the
insurers. The management is, however, subject to the insurers' investment
guidelines and the ultimate control of each insurer's board of directors. The
management fee is a percentage of the total amount under management. The annual
investment fees paid by the insurance companies in 1999 were approximately
$335,000 and in 2000 were approximately $400,000.
Effective January 1, 1999, Sierra and California Indemnity Insurance
Company agreed that Sierra would furnish it services, including accounting,
human resources, systems and other administrative services. The fee for the
services is based on the lower of actual cost or fair market value. The services
are subject to the ultimate control of California Indemnity Insurance Company's
board of directors. The annual fees for these services were approximately
$1,003,000 in 1999 and $1,200,000 in 2000.
On March 31, 2000, California Indemnity Insurance Company loaned $7.4
million to Sierra, its ultimate parent. The loan was secured by a first trust
deed mortgage on property at 4475 South Eastern Avenue in Las Vegas, Nevada. The
loan is due April 1, 2005 with a right to accelerate on the part of the lender
on or after April 1, 2001. The interest rate for the loan is 8% per annum and
the loan to value was approximately 60%. Sierra Health Services has paid
$441,000 as of November 30, 2000 in interest from the date of the loan. A sale
of the 4475 South Eastern property to a non-affiliated real estate partnership
closed December 28, 2000. Under the terms of the purchase and sale agreement,
the purchaser assumed the first trust deed mortgage with amended terms. The
interest rate was increased and the acceleration clause was eliminated by
payment of additional fees, and the loan's maturity was set at December 31, 2001
with the ability of the borrower to extend for two periods of six months,
subject to notice before the extension and payment to California Indemnity
Insurance Company of additional fees.
Sierra, California Indemnity Insurance Company and Commercial Casualty
Insurance Company are partners in a limited partnership called 2716 North Tenaya
Way Limited Partnership. This partnership owns the building located at that
address in Las Vegas, Nevada. The two insurers are limited partners in the
partnership whereas Sierra Health Services is the general partner. The two
limited partners own approximately 13.5% of the partnership each. They also
lease a portion of the building from the partnership. The lease payments during
1999 for both companies were $1,168,000 and for this year to date were
$1,160,000 as of November 30, 2000. A sale of the partnership's building to a
third party closed on December 28, 2000. At closing, the net proceeds to the two
limited partners were approximately $8 million in total and the original
lease was
canceled effective December 28, 2000. Sierra entered into a 15 year master lease
with the new owner of the property. Sierra and California Indemnity Insurance
Company have entered into a new one-year sublease, for the space occupied by
California Indemnity Insurance Company, effective January 1, 2001. The total
amount of rent under the sublease will be approximately equivalent to that under
the former lease with the partnership and will be determined based upon the new
lease costs of Sierra under the master lease. The sublease is subject to the
provisions of the master lease. It will automatically renew from year to year
unless California Indemnity Insurance Company gives notice to cease renewing on
or before December 1 in any year. The renewal can not extend beyond the length
of the master lease.
Effective January 1, 1996, federal income taxes are calculated pursuant to
a tax allocation agreement between Sierra and CII Financial. Income taxes are
allocated on a separate return basis for each company and tax benefits are
recorded only to the extent that an entity could recoup taxes paid in prior
years.
All of our directors are also executive officers of Sierra.
PRINCIPAL STOCKHOLDERS
Sierra owns 100% of our issued and outstanding capital stock.
DESCRIPTION OF OTHER INDEBTEDNESS
Sierra's credit facility is governed by an Amended and Restated Credit
Agreement entered into by Sierra on December 15, 2000 with a syndicate of banks
for which Bank of America, N.A., is the Administrative Agent and Issuing Bank.
Other lenders include First Union National Bank, Deutsche Bank, AG, Credit
Lyonnais, Bank One, N.A., Wells Fargo Bank, N.A., and Union Bank of California,
N.A. Bank of America, N.A. is an affiliate of Banc of America Securities LLC,
the dealer manager for the exchange offer. The new credit agreement amended
Sierra's preceding credit agreement, which Sierra entered into in 1998. Sierra
was not in compliance with the terms of the financial covenants in the preceding
credit agreement and received a notice of default from its lenders on November
8, 2000 with respect to this non-compliance. Since December 15, 2000, Sierra has
been in compliance with the covenants under the Amended and Restated Credit
Agreement.
We have irrevocably and unconditionally guaranteed all obligations under
this credit facility.
Revolving Loans
The new credit agreement currently provides Sierra with a revolving credit
facility of $135 million. The proceeds from revolving loans under the revolving
credit facility may be used for general working capital and general corporate
purposes. As of December 31, 2000, the facility was fully drawn with an
outstanding balance of $135 million.
The available amounts which Sierra can borrow under the credit facility
will be reduced by specified amounts, on certain dates. If the total amount of
outstanding loans exceeds the availability under the credit facility, as
reduced, Sierra will be required to immediately prepay 100% of the excess
amount.
Under certain additional circumstances, Sierra would be required to make
prepayments of the loans, and the amount available to Sierra under the revolving
credit facility would be reduced. For example, 80% of any excess cash flow that
Sierra has in each year must be applied to a repayment of the loans and a
reduction of the amount available under the revolving credit facility. In
addition, if Sierra or a subsidiary of Sierra (other than an HMO subsidiary and
certain other subsidiaries) engages in an asset sale or a sale-leaseback
transaction (with the exception of certain assets specified in the new credit
agreement), 80% of the cash proceeds (net of certain expenses) must be applied
to a repayment of the loans and a reduction of the amount available under the
revolving credit facility. Similarly, 80% of the cash proceeds (net of certain
expenses) of certain equity issuances by us or any of our subsidiaries and 100%
of the cash proceeds (net of certain expenses) of a debt issuance by Sierra
(excluding us) must be applied to a repayment of the loans and a reduction in
the amount available under the revolving credit facility.
The credit facility terminates on September 30, 2003. On that date, Sierra
will be required to repay the aggregate principal amount of the revolving loans
outstanding.
Interest
Under the credit facility, revolving loans bear interest at the applicable
margin plus the greater of:
o 0.5% per annum above the latest federal funds rate; or
o the per annum prime lending rate of Bank of America, N.A.
The applicable margin is initially 1.75%. However, the applicable margin
may be increased or decreased in certain circumstances.
Fees
In connection with the credit facility, Sierra will pay certain customary
fees, including agents' fees, commitment fees, and amendment fees.
Covenants
Subject to normal qualifications and exceptions, Sierra has certain
covenants that, among other things, will restrict the ability of Sierra and its
subsidiaries, including CII Financial, to dispose of assets, incur indebtedness,
pay dividends, make investments, loans or advances, make acquisitions, engage in
mergers or consolidations, or make capital expenditures and which otherwise
restrict certain corporate activities. In addition, under the senior credit
facility Sierra will be required to comply with specified financial ratios, as
defined in the credit agreement, including minimum interest coverage ratios and
leverage ratios.
Events of Default
The credit facility may be terminated before September 30, 2003 upon the
occurrence of any event of default. Upon the occurrence of an event of default,
with certain limitations, Sierra's obligations under the new credit agreement
which are at that time outstanding may become accelerated. Events of default
under the credit facility consist of customary specified events. A default in
payment on our debentures would constitute an event of default. A bankruptcy
proceeding or other similar event involving us would also constitute an event of
default.
Security
The payment and performance of Sierra's obligations under the credit
facility are secured by:
o liens on substantially all of Sierra's assets and the assets of
Sierra's subsidiaries, other than CII
Financial and Sierra's other regulated subsidiaries;
o a guaranty of Sierra's obligations thereunder by each of Sierra's
subsidiaries, including CII Financial, but excluding our insurance
subsidiaries and Sierra's other regulated subsidiaries; and
o other collateral arrangements, subject to pledge agreements, the
security agreements, deeds of trust, and similar arrangements between
Sierra, Sierra's subsidiaries, and the lending banks.
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
We have set out below our unaudited pro forma consolidated financial
statements.
Due to the possibility of different outcomes to the exchange offer based
upon the elections made by tendering holders, we are demonstrating three
different presentations of pro forma financial information as illustrations of
the range of potential results.
Presentation one assumes the exchange of $47,059,000 in principal amount of
old junior subordinated debentures for $10,237,500 in cash and $27,559,000 in
principal amount of new 9% senior subordinated debentures.
Presentation two assumes the exchange of $47,059,000 in principal amount of
old junior subordinated debentures for $5,250,000 in cash and $37,059,000 in
principal amount of new 9% senior subordinated debentures.
Presentation three assumes the exchange of $47,059,000 in principal
amount of old junior subordinated debentures for $47,059,000 in principal amount
of new 9% senior subordinated debentures.
Each of the unaudited pro forma consolidated balance sheets as of September
30, 2000 have been prepared on the basis that the exchange offer as described
above had occurred on September 30, 2000. Each of the unaudited pro forma
consolidated statements of operations for the nine months ended September 30,
2000 and the year ended December 31, 1999 have been prepared as if the exchange
offer had occurred on January 1, 1999.
You should read this information with the accompanying notes and our
consolidated financial statements, which are included in this prospectus. The
accompanying pro forma consolidated financial statements do not purport to
represent what our results of operations would have been had such transactions
and events occurred on the dates specified, or to project our results of
operations for any future period or date. The pro forma adjustments are based on
available information and certain adjustments that our management believes are
reasonable. In the opinion of our management, all adjustments have been made
that are necessary to present fairly the unaudited pro forma consolidated data.
PRESENTATION ONE
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2000
Presentation one assumes the exchange of $47,059,000 in principal
amount of old junior subordinated debentures for $10,237,500 in cash and
$27,559,000 in principal amount of new 9% senior subordinated debentures.
The accompanying unaudited pro forma consolidated balance sheet
reflects the following adjustments:
(a) Payment of the outstanding accrued interest on the old junior
subordinated debentures as of September 30, 2000 of $145,000.
(b) Payment of $1,600,000 in debt issuance costs to be recognized as
expense in the period incurred. This amount is reflected in equity net of tax
expense and as a deferred tax asset.
(c) A $5,000,000 loan from Sierra to the CII Financial evidenced by the
affiliate note.
(d) An exchange of $27,559,000 aggregate principal amount of the old
junior subordinated debentures for new senior subordinated debentures in the
aggregate principal amount of $27,559,000 and a deferred gain of $9,262,500 to
be amortized over the term of the new senior subordinated debentures.
(e) $19,500,000 aggregate principal amount of old junior subordinated
debentures retired in exchange for a $10,237,500 cash payment.
CII FINANCIAL, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2000
(In thousands, except for share data)
Historical Adjustments Pro forma
ASSETS
Invested assets:
Debt securities, available for sale, at fair value $164,660 $164,660
Debt securities, held-to-maturity, at amortized cost 22,154 22,154
Preferred stock, at fair value 1,732 1,732
Mortgage loans on non-affiliated real estate 6,281 6,281
------ -----
- ---------------------------------------------------------
Total invested assets 194,827 194,827
Cash and cash equivalents 19,408 $(6,983) (a),(b),(c),(e) 12,425
Reinsurance recoverable 211,594 211,594
Premiums receivable (net of allowance of $1,134) 13,402 13,402
Investment income receivable 2,406 2,406
Deferred policy acquisition costs 2,732 2,732
Mortgage loans on affiliated real estate 10,261 10,261
Real estate limited partnership 7,108 7,108
Federal income taxes receivable 9,478 9,478
Deferred income taxes 15,984 560 (b) 16,544
Property and equipment, net 5,097 5,097
Other assets 555 555
- --------------------------------------------------------- ------------- ---------------- ------------
TOTAL ASSETS $492,852 $(6,423) $486,429
LIABILITIES
Reserve for losses and loss adjustment expenses $341,902 $341,902
Unearned premiums 16,206 16,206
Ceded reinsurance premiums payable 7,424 7,424
Old junior subordinated debentures 47,059 $(47,059) (d),(e) 0
New senior subordinated debentures 36,821 (d) 36,821
Accounts payable and other accrued expenses 15,969 (145) (a) 15,824
Affiliate note 5,000 (c) 5,000
Payable to affiliates 2,487 2,487
Deferred tax liability 3,291 3,291
- --------------------------------------------------------- ------------- ---------------- ------------
TOTAL LIABILITIES 434,338 (5,383) 428,955
COMMITMENTS AND CONTINGENCIES
STOCKHOLDER'S EQUITY
Common Stock, no par value, 1,000 shares
Authorized; shares issued and outstanding - 100 3,604 3,604
Additional paid - in capital 64,450 64,450
Accumulated other comprehensive loss:
Unrealized holding loss on available-for
sale-investments (8,651) (8,651)
Accumulated deficit (889) (1,040) (b) (1,929)
- --------------------------------------------------------- ------------- ---------------- ------------
TOTAL STOCKHOLDER'S EQUITY 58,514 (1,040) 57,474
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $492,852 $(6,423) $486,429
==============================================================================
See the accompanying notes on page 70
PRESENTATION ONE
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND YEAR ENDED DECEMBER 31, 1999
Presentation one assumes the exchange of $47,059,000 in principal
amount of old junior subordinated debentures for $10,237,500 in cash and
$27,559,000 in principal amount of new 9% senior subordinated debentures.
The accompanying unaudited pro forma consolidated statement of
operations reflects the following adjustments:
(f) Decrease in investment income as a result of less cash available
during the period for investments. Amount is calculated based on net cash used
for the transaction and the average investment yield during the period of
approximately 6.5%.
(g) Recognition of the $1,600,000 in debt issuance costs as incurred.
(h) Adjustment of interest expense based on a reduction in the
outstanding principal balance and an increase in the interest rate of the
outstanding debentures as a result of the exchange. Historical figures are based
on a weighted average of $48,302,000 and $50,875,000 in outstanding junior
subordinated debentures during the periods ending September 30, 2000 and
December 31, 1999, respectively, at a 7.5% interest rate. Pro forma figures are
based on $27,559,000 in outstanding senior subordinated debentures at a 9%
interest rate.
(i) Interest expense on the $5,000,000 affiliate note based on a
9% rate of interest.
(j) Reduction of interest expense for the amortization of the deferred
gain on the restructuring of the old junior subordinated debentures. The
deferred gain of $9,262,500 will be amortized over the life of the new senior
subordinated debentures using the effective interest rate method.
(k) A reduction of income taxes as a result of the pro forma
adjustments at an assumed effective tax rate of 35%.
PRESENTATION ONE
CII FINANCIAL, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2000
(In thousands)
Historical Adjustments Pro forma
REVENUES
Direct written premiums $153,034 $153,034
Changes in direct unearned premiums (2,906) (2,906)
Direct earned premiums 150,128 150,128
Less: premiums ceded 59,177 59,177
Net earned premiums 90,951 90,951
Net investment income 11,217 $(340) (f) 10,877
Net realized investment losses (460) (460)
Total revenues 101,708 (340) 101,368
COSTS AND EXPENSES
Losses and loss adjustment expenses 207,323 207,323
Reinsurance recoveries (123,303) (123,303)
Net loss and loss adjustment expenses 84,020 84,020
Policy acquisition costs 8,606 8,606
General and administrative and other 17,372 17,372
Asset impairment 3,000 3,000
Interest expense 2,717 (1,335) (h), (i),(j) 1,382
Total costs and expenses 115,715 (1,335) 114,380
LOSS BEFORE FEDERAL INCOME TAX BENEFIT (14,007) 995 (13,012)
Federal income tax benefit (4,902) 348 (k) (4,554)
(LOSS) INCOME FROM CONTINUING OPERATIONS $(9,105) $647 $(8,458)
===============================================================================
See the accompanying notes on page 72
PRESENTATION ONE
CII FINANCIAL, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1999
(In thousands)
Historical Adjustments Pro forma
REVENUES
Direct written premiums $148,824 $148,824
Changes in direct unearned premiums (2,142) (2,142)
Direct earned premiums 146,682 146,682
Less: premiums ceded 63,727 63,727
Net earned premiums 82,955 82,955
Net investment income 15,776 $(454) (f) 15,322
Net realized investment losses (381) (381)
Total revenues 98,350 (454) 97,896
COSTS AND EXPENSES
Losses and loss adjustment expenses 157,424 157,424
Reinsurance recoveries (95,963) (95,963)
Net loss and loss adjustment expenses 61,461 61,461
Policy acquisition costs 6,339 6,339
General and administrative and other 19,749 1,600 (g) 21,349
Interest expense 3,706 (1,866) (h), (i), (j) 1,840
Total costs and expenses 91,255 (266) 90,989
LOSS BEFORE FEDERAL INCOME TAX BENEFIT 7,095 (188) 6,907
Federal income tax benefit 3,602 (66) (k) 3,536
INCOME (LOSS) FROM CONTINUING OPERATIONS $3,493 $(122) $3,371
==============================================================================
See the accompanying notes on page 72
PRESENTATION TWO
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2000
Presentation two assumes the exchange of $47,059,000 in principal
amount of old junior subordinated debentures for $5,250,000 in cash and
$37,059,000 in principal amount of new 9% senior subordinated debentures.
The accompanying unaudited pro forma consolidated balance sheet
reflects the following adjustments:
(l) Payment of the outstanding accrued interest on the old junior
subordinated debentures as of September 30, 2000 of $145,000.
(m) Payment of $1,600,000 in debt issuance costs to be recognized as
expense in the period incurred. This amount is reflected in equity net of tax
expense and as a deferred tax asset.
(n) An exchange of $37,059,000 aggregate principal amount of the old
junior subordinated debentures for new senior subordinated debentures in the
aggregate principal amount of $37,059,000 and a deferred gain of $4,750,000 to
be amortized over the term of the new senior subordinated debentures.
(o) $10,000,000 aggregate principal amount of old junior subordinated
debentures retired in exchange for a $5,250,000 cash payment.
PRESENTATION TWO
CII FINANCIAL, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2000
(In thousands, except for share data)
Historical Adjustments Pro forma
ASSETS
Invested assets:
Debt securities, available for sale, at fair value $164,660 $164,660
Debt securities, held-to-maturity, at amortized cost 22,154 22,154
Preferred stock, at fair value 1,732 1,732
Mortgage loans on non-affiliated real estate 6,281 6,281
-------------- -------------
Total invested assets 194,827 194,827
-------------- -------------
Cash and cash equivalents 19,408 $(6,995) (l),(m),(o) 12,413
Reinsurance recoverable 211,594 211,594
Premiums receivable (net of allowance of $1,134) 13,402 13,402
Investment income receivable 2,406 2,406
Deferred policy acquisition costs 2,732 2,732
Mortgage loans on affiliated real estate 10,261 10,261
Real estate limited partnership 7,108 7,108
Federal income taxes receivable 9,478 9,478
Deferred income taxes 15,984 560 (m) 16,544
Property and equipment, net 5,097 5,097
Other assets 555 555
TOTAL ASSETS ------------- ---------------- ------------
$492,852 $(6,435) $486,417
LIABILITIES
Reserve for losses and loss adjustment expenses $341,902 $341,902
Unearned premiums 16,206 16,206
Ceded reinsurance premiums payable 7,424 7,424
Old junior subordinated debentures 47,059 $(47,059) (n),(o) 0
New senior subordinated debentures 41,809 (n) 41,809
Accounts payable and other accrued expenses 15,969 (145) (l) 15,824
Payable to affiliates 2,487 2,487
Deferred tax liability 3,291 3,291
TOTAL LIABILITIES ------------- ---------------- ------------
434,338 (5,395) 428,943
COMMITMENTS AND CONTINGENCIES
STOCKHOLDER'S EQUITY
Common Stock, no par value, 1,000 shares
authorized; shares issued and outstanding - 100 3,604 3,604
Additional paid - in capital 64,450 64,450
Accumulated other comprehensive loss:
Unrealized holding loss on available-for (8,651) (8,651)
sale-investments
Accumulated deficit (889) (1,040) (m) (1,929)
TOTAL STOCKHOLDER'S EQUITY ------------- ---------------- ------------
58,514 (1,040) 57,474
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $492,852 $(6,435) $486,417
=============================================================================
See the accompanying notes on page 75
PRESENTATION TWO
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND YEAR ENDED DECEMBER 31, 1999
Presentation two assumes the exchange of $47,059,000 in principal
amount of old junior subordinated debentures for $5,250,000 in cash and
$37,059,000 in principal amount of new 9% senior subordinated debentures.
The accompanying unaudited pro forma consolidated statement of
operations reflects the following adjustments:
(p) Decrease in investment income as a result of less cash available
during the period for investments. Amount is calculated based on net cash used
for the transaction and the average investment yield during the period of
approximately 6.5%.
(q) Recognition of the $1,600,000 in debt issuance costs as incurred.
(r) Adjustment of interest expense based on a reduction in the
outstanding principal balance and an increase in the interest rate of the
outstanding debentures as a result of the exchange. Historical figures are based
on a weighted average of $48,302,000 and $50,875,000 in outstanding junior
subordinated debentures during the periods ending September 30, 2000 and
December 31, 1999, respectively, at a 7.5% interest rate. Pro forma figures are
based on $37,059,000 in outstanding senior subordinated debentures at a 9%
interest rate.
(s) Reduction of interest expense for the amortization of the deferred
gain on the restructuring of the old junior subordinated debentures. The
deferred gain of $5,750,000 will be amortized over the life of the new senior
subordinated debentures using the effective interest rate method.
(t) A reduction of income taxes as a result of the pro forma
adjustments at an assumed effective tax rate of 35%.
PRESENTATION TWO
CII FINANCIAL, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2000
(In thousands)
Historical Adjustments Pro forma
REVENUES
Direct written premiums $153,034 $153,034
Changes in direct unearned premiums (2,906) (2,906)
Direct earned premiums 150,128 150,128
Less: premiums ceded 59,177 59,177
Net earned premiums 90,951 90,951
Net investment income 11,217 $(341) (p) 10,876
Net realized investment losses (460) (460)
-------------------
Total revenues 101,708 (341) 101,367
-------------------
COSTS AND EXPENSES
Losses and loss adjustment expenses 207,323 207,323
Reinsurance recoveries (123,303) (123,303)
Net loss and loss adjustment expenses 84,020 84,020
Policy acquisition costs 8,606 8,606
General and administrative and other 17,372 17,372
Asset impairment 3,000 3,000
Interest expense 2,717 (601) (r),(s) 2,116
Total costs and expenses 115,715 (601) 115,114
LOSS BEFORE FEDERAL INCOME TAX BENEFIT (14,007) 260 (13,747)
Federal income tax benefit (4,902) 91 (t) (4,811)
(LOSS) INCOME FROM CONTINUING OPERATIONS $(9,105) $169 $(8,936)
==============================================================================
See the accompanying notes on page 77
PRESENTATION TWO
CII FINANCIAL, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1999
(In thousands)
Historical Adjustments Pro forma
REVENUES
Direct written premiums $148,824 $148,824
Changes in direct unearned premiums (2,142) (2,142)
Direct earned premiums 146,682 146,682
Less: premiums ceded 63,727 63,727
Net earned premiums 82,955 82,955
Net investment income 15,776 $(454) (p) 15,322
Net realized investment losses (381) (381)
-------------------
Total revenues 98,350 (459) 97,896
-------------------
COSTS AND EXPENSES
Losses and loss adjustment expenses 157,424 157,424
Reinsurance recoveries (95,963) (95,963)
Net loss and loss adjustment expenses 61,461 61,461
Policy acquisition costs 6,339 6,339
General and administrative and other 19,749 1,600 (q) 21,349
Interest expense 3,706 (934) (r),(s) 2,772
Total costs and expenses 91,255 666 91,921
LOSS BEFORE FEDERAL INCOME TAX BENEFIT 7,095 (1,120) 5,975
Federal income tax benefit 3,602 (392) (t) 3,210
INCOME (LOSS) FROM CONTINUING OPERATIONS $3,493 $(728) $2,765
==============================================================================
See the accompanying notes on page 77
PRESENTATION THREE
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2000
Presentation three assumes the exchange of $47,059,000 in principal
amount of old junior subordinated debentures for $47,059,000 in principal amount
of new 9% senior subordinated debentures.
The accompanying unaudited pro forma consolidated balance sheet
reflects the following adjustments:
(u) Payment of the outstanding accrued interest on the old junior
subordinated debentures as of September 30, 2000 of $145,000.
(v) Payment of $1,600,000 in debt issuance costs to be recognized as
expense in the period incurred. This amount is refleced as an after tax expense
and a deferred tax asset.
(w) An exchange of $47,059,000 aggregate principal amount of the old
junior subordinated debentures for new senior subordinated debentures in the
aggregate principal amount of $47,059,000.
PRESENTATION THREE
CII FINANCIAL, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2000
(In thousands, except for share data)
Historical Adjustments Pro forma
ASSETS
Invested assets:
Debt securities, available for sale, at fair value $164,660 $164,660
Debt securities, held-to-maturity, at amortized cost 22,154 22,154
Preferred stock, at fair value 1,732 1,732
Mortgage loans on non-affiliated real estate 6,281 6,281
-------------- -------------
Total invested assets 194,827 194,827
-------------- -------------
Cash and cash equivalent 19,408 $(1,745) (u),(v) 17,663
Reinsurance recoverable 211,594 211,594
Premiums receivable (net of allowance of $1,134) 13,402 13,402
Investment income receivable 2,406 2,406
Deferred policy acquisition costs 2,732 2,732
Mortgage loans on affiliated real estate 10,261 10,261
Real estate limited partnership 7,108 7,108
Federal income taxes receivable 9,478 9,478
Deferred income taxes 15,984 560 (v) 16,544
Property and equipment, net 5,097 5,097
Other assets 555 555
TOTAL ASSETS ------------- ---------------- ------------
$492,852 $(1,185) $491,667
LIABILITIES
Reserve for losses and loss adjustment expenses $341,902 $341,902
Unearned premiums 16,206 16,206
Ceded reinsurance premiums payable 7,424 7,424
Old junior subordinated debentures 47,059 $(47,059) (w) 0
New senior subordinated debentures 47,059 (w) 47,059
Accounts payable and other accrued expenses 15,969 (145) (u) 15,824
Payable to affiliates 2,487 2,487
Deferred tax liability 3,291 3,291
TOTAL LIABILITIES ------------- ---------------- ------------
434,338 (145) 434,193
COMMITMENTS AND CONTINGENCIES
STOCKHOLDER'S EQUITY
Common Stock, no par value, 1,000 shares
Authorized; shares issued and outstanding - 100 3,604 3,604
Additional paid - in capital 64,450 64,450
Accumulated other comprehensive loss:
Unrealized holding loss on available-for (8,651) (8,651)
sale-investments
Accumulated deficit (889) (1,040) (v) (1,929)
TOTAL STOCKHOLDER'S EQUITY ------------- ---------------- ------------
58,514 (1,040) 57,474
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $492,852 $(1,185) $491,667
See the accompanying notes on page 80
===================================================================================================================
PRESENTATION THREE
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND YEAR ENDED DECEMBER 31, 1999
Presentation three assumes the exchange of $47,059,000 in principal
amount of old junior subordinated debentures for $47,059,000 in principal amount
of new 9% senior subordinated debentures.
The accompanying unaudited pro forma consolidated statement of
operations reflects the following adjustments:
(x) Decrease in investment income as a result of less cash available
during the period for investments. Amount is calculated based on net cash used
for the transaction and the average investment yield during the period of
approximately 6.5%.
(y)Recognition of the $1,600,000 in debt issuance costs as incurred.
(z)Adjustment of interest expense based on a reduction in the
outstanding principal balance and an increase in the interest rate of the
outstanding debentures as a result of the exchange. Historical figures are based
on a weighted average of $48,302,000 and $50,875,000 in outstanding junior
subordinated debentures during the periods ending September 30, 2000 and
December 31, 1999, respectively, at a 7.5% interest rate. Pro forma figures are
based on $47,059,000 in outstanding senior subordinated debentures at a 9%
interest rate.
(A) A reduction of income taxes as a result of the pro forma
adjustments at an assumed effective tax rate of 35%.
PRESENTATION THREE
CII FINANCIAL, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2000
(In thousands)
Historical Adjustments Pro forma
REVENUES
Direct written premiums $153,034 $153,034
Changes in direct unearned premiums (2,906) (2,906)
Direct earned premiums 150,128 150,128
Less: premiums ceded 59,177 59,177
Net earned premiums 90,951 90,951
Net investment income 11,217 $(85) (x) 11,132
Net realized investment losses (460) (460)
-------------------
Total revenues 101,708 (85) 101,623
-------------------
COSTS AND EXPENSES
Losses and loss adjustment expenses 207,323 207,323
Reinsurance recoveries (123,303) (123,303)
Net loss and loss adjustment expenses 84,020 84,020
Policy acquisition costs 8,606 8,606
General and administrative and other 17,372 17,372
Asset impairment 3,000 3,000
Interest expense 2,717 459 (z) 3,176
Total costs and expenses 115,715 459 116,174
LOSS BEFORE FEDERAL INCOME TAX BENEFIT (14,007) (544) (14,551)
Federal income tax benefit (4,902) (191) (z) (5,093)
(LOSS) INCOME FROM CONTINUING OPERATIONS $(9,105) $(353) $(9,458)
==============================================================================
See the accompanying notes on page 82
PRESENTATION THREE
CII FINANCIAL, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1999
(In thousands)
Historical Adjustments Pro forma
REVENUES
Direct written premiums $148,824 $148,824
Changes in direct unearned premiums (2,142) (2,142)
Direct earned premiums 146,682 146,682
Less: premiums ceded 63,727 63,727
Net earned premiums 82,955 82,955
Net investment income 15,776 $(113) (x) 15,663
Net realized investment losses (381) (381)
-------------------
Total revenues 98,350 (113) 98,237
-------------------
COSTS AND EXPENSES
Losses and loss adjustment expenses 157,424 157,424
Reinsurance recoveries (95,963) (95,963)
Net loss and loss adjustment expenses 61,461 61,461
Policy acquisition costs 6,339 6,339
General and administrative and other 19,749 1,600 (y) 21,349
Interest expense 3,706 420 (z) 4,126
Total costs and expenses 91,255 2,020 93,275
LOSS BEFORE FEDERAL INCOME TAX BENEFIT 7,095 (2,133) 4,962
Federal income tax benefit 3,602 (747) (A) 2,855
INCOME (LOSS) FROM CONTINUING OPERATIONS $3,493 $(1,386) $2,107
============================================================================
See the accompanying notes on page 82
DESCRIPTION OF DEBENTURES
Principal Differences Between Old Junior Subordinated Debentures and New Senior
Subordinated Debentures
The terms of the new senior subordinated debentures and the related
indenture are identical in all material respects to the terms of the old junior
subordinated debentures and the related indenture, except for:
o The new senior subordinated debentures will rank senior in right of
payment to any old junior subordinated debentures which are not
tendered.
o You will receive a higher rate of interest on the new senior
subordinated debentures, which will pay 9% per annum, than on the old
junior subordinated debentures, which pay 7 1/2% per annum.
o The scheduled maturity date of the new senior subordinated debentures
is September 15, 2006, which is five years later than September 15,
2001, the scheduled maturity date of the old junior subordinated
debentures.
o The new senior subordinated debentures will not be convertible into
Sierra common stock. The old junior subordinated debentures are
convertible into Sierra common stock at $39.398 per share.
New Senior Subordinated Debentures
We will issue the new senior subordinated debentures under an indenture
between us and Wells Fargo Bank Minnesota, N.A., as trustee. A copy of the
indenture substantially in the form in which it is to be executed is filed as an
exhibit to the registration statement of which this prospectus is a part.
The following description is a summary of the material provisions of the
indenture relating to the new senior subordinated debentures and does not
describe the indenture in its entirety. This summary is subject to and qualified
by reference to all of the provisions in the indenture, including definitions of
certain terms used in the indenture. We urge you to read the indenture because
it, and not the summary description below, defines your rights. Copies of the
indenture will be available for inspection at the Corporate Trust Offices of the
trustee in Minneapolis, Minnesota.
General. The new senior subordinated debentures will be limited to
$47,059,000 aggregate principal amount. The new senior subordinated debentures
will be subordinated obligations of CII Financial and will not be guaranteed by
Sierra. The new senior subordinated debentures will be subordinate to all our
senior indebtedness, including our guaranty of Sierra's credit facility and the
affiliate note. However, the new senior subordinated debentures will rank senior
to the old junior subordinated debentures. We are required to repay the
principal amount of the new senior subordinated debentures in full on September
15, 2006.
The new senior subordinated debentures will bear interest from the date of
issuance, at the rate per annum of 9%. We will pay interest on the new senior
subordinated debentures on March 15 and September 15 of each year, commencing on
March 15, 2001, to the person in whose name the new debenture (or any
predecessor debenture) is registered, subject to certain exceptions, at the
close of business on March 1 or September 1, as the case may be, before each
interest payment date. Principal and interest on the new senior subordinated
debentures will be payable and transfers will be registrable, at an office of
the trustee or our office or agency maintained for such purpose in Minneapolis,
Minnesota, provided that, at our option, payment of interest may be made by
check mailed to the address of the person entitled thereto as it appears in the
debenture register.
Subordination of Debentures. The payment of principal, any premium and
interest on the new senior subordinated debentures, including amounts payable on
any redemption or repurchase, will be subordinated to the prior payment in full
of all our senior debt. The new senior subordinated debentures will rank senior
to the old junior subordinated debentures. Senior debt is defined in the
indenture as the principal of, and interest on all our debt, whether outstanding
on the date of the indenture or thereafter created, incurred, guaranteed or
assumed, other than
o the new senior subordinated debentures;
o the old junior subordinated debentures; and
o any debt which provides, or in respect of which any instrument
creating or evidencing such debt or pursuant to which the same is
outstanding provides, that such debt is not superior in right of
payment to the new senior subordinated debentures.
Debt is defined in the indenture to mean:
o all debt which is (a) for money borrowed, (b) evidenced by a note,
bond or similar instrument given in connection with the acquisition of
any businesses, properties or assets of any kind, but excluding any
other trade accounts payable or accrued liabilities arising in the
ordinary course of business or (c) purchase money indebtedness with
respect to the purchase of any real or personal property or any
interest therein;
o obligations under certain leases;
o amendments, renewals, extensions, modifications and refundings of any
debt or obligations referred to above; and
o any debt or obligations referred to above in respect of which we are
liable, contingently or otherwise, to pay or advance money or property
as a guarantor, endorser or otherwise.
In August 2000, we became a guarantor of Sierra's revolving credit
facility, which at December 31, 2000 was fully drawn and had an outstanding
balance of $135 million. The new senior subordinated debentures are subordinated
to this guaranty of the credit facility debt. Our senior debt will also include
the affiliate note. The terms of our debentures do not limit our ability to
incur additional senior debt. As of December 31, 2000, other than debt incurred
in the ordinary course of business, we had $182,059,000 of indebtedness,
consisting of the old junior subordinated debentures and the credit facility
guaranty.
Upon any payment or distribution of assets to creditors as a result of a
liquidation, dissolution, winding up, reorganization for the benefit of
creditors, marshalling of assets or any bankruptcy, insolvency or similar
proceedings involving us, the holders of all senior debt will first be entitled
to receive payment in full before you will be entitled to receive any payment on
the new senior subordinated debentures. No such payment in respect of the new
senior subordinated debentures may be made if there shall have occurred and be
continuing a default in any payment with respect to any senior debt, or an event
of default in respect to any senior debt resulting in acceleration of the
maturity thereof, or if any judicial proceeding shall be pending with respect to
any such default. If the new senior subordinated debentures are declared due and
payable before their stated maturity, no payment may be made in respect of the
new senior subordinated debentures unless and until all senior debt shall have
been paid in full.
By reason of such subordination, in the event of insolvency, our creditors
who are holders of senior debt may recover more ratably than you will. The new
senior subordinated debentures will be senior to the old junior subordinated
debentures.
The indenture will permit the trustee to become our creditor and to enforce
its rights as a creditor, including rights as a holder of senior debt.
Redemption. The new senior subordinated debentures will be redeemable upon
not less than 25 nor more than 60 days' notice by mail at any time, in whole or
in part, at our election, on or prior to September 15, 2001 at a redemption
price equal to 100.75% of the principal amount together with accrued interest to
the redemption date, or after September 15, 2001 at a redemption price equal to
100% of the principal amount together with accrued interest to the redemption
date, subject to the right of holders of record on regular record dates to
receive interest due on an interest payment date.
Repurchase at Option of Holders Upon Change in Control. If a change in
control as defined below occurs, you will have the right, at your option, to
require us to repurchase for cash all of your new senior subordinated debentures
not previously called for redemption, or any portion of the principal amount
thereof, that is equal to $1,000 or an integral multiple of $1,000. The price we
are required to pay is 100% of the principal amount of the new senior
subordinated debentures to be repurchased, together with accrued interest to the
repurchase date. Such right may not be waived by our board of directors. Within
30 days after the occurrence of a change in control, we are obligated to mail to
you notice of such change in control and of the repurchase right arising as a
result thereof. We must also deliver a copy of this notice to the trustee and
cause a copy of such notice to be published in a newspaper of general
circulation in Los Angeles, California and in the Borough of Manhattan, The City
of New York. To exercise the repurchase right, you must deliver to the trustee
the new senior subordinated debentures with respect to which the repurchase
right is being exercised, duly endorsed for transfer to us. We are required to
repurchase the new senior subordinated debentures on the date that is 45 days
after the date of our notice, which we refer to as the repurchase date.
A change in control will be deemed to have occurred at the time after the
new senior subordinated debentures are issued that any person, including any
syndicate or group deemed to be a "Person" under Section 13(d)(3) of the
Exchange Act, is or becomes the beneficial owner, directly or indirectly,
through a purchase, merger or other acquisition transaction or series of
transactions, of shares of our capital stock entitling such person to exercise
50% or more of the total voting power of all shares of our capital stock that
are entitled to vote in elections of directors. For purposes of these
provisions, whether a person is a "beneficial owner" will be determined in
accordance with Rule l3d-3 promulgated by the SEC under the Exchange Act as in
effect on the date of execution of the indenture.
Merger and Consolidation. The indenture will provide that we may
consolidate with or merge into any other corporation, or convey, transfer or
lease its properties and assets substantially as an entirety to any person,
provided that in any such case:
o the successor corporation assumes by a supplemental indenture our
obligations under the indenture;
o immediately after giving effect to such transaction, no default will have
occurred and be continuing; and
o we deliver to the trustee an officer's certificate and an opinion of
counsel stating that the terms of the indenture with respect to such
event have been complied with.
Upon compliance with these provisions by a successor corporation, we,
except in the case of a lease, would be relieved of our obligations under the
indenture and the new senior subordinated debentures.
Modification of the Indenture. Modifications and amendments of the
indenture may be made by us and the trustee with the consent of the holders of a
majority in principal amount of the outstanding debentures. However, none of the
following modifications or amendments may be made without your consent:
o change the stated maturity date of the principal of, or any installment
of interest on, the new senior subordinated debentures;
o reduce the principal amount of, any interest on, or premium payable on
redemption of, any new debenture;
o change the place or currency of payment on the new senior subordinated
debentures;
o impair your right to institute suit for the enforcement of any payment on
the new senior subordinated debentures when due;
o modify the provisions of the indenture with respect to the subordination
of the new senior subordinated debentures in a manner adverse to you; or
o reduce the percentage in principal amount of new senior subordinated
debentures the consent of whose holders is required for modification
or amendment of the indenture or for waiver of compliance with certain
provisions of the indenture or for waiver of certain defaults.
Events of Default, Notice and Waiver. The following are events of default
under the indenture:
o we fail to make a payment of interest on the new senior subordinated
debentures when due, and this failure continues for 30 days;
o we fail to make the payment of principal on the new senior subordinated
debentures, when due;
o we fail in the performance of any other covenant and this failure
continues for 60 days after written notice, as provided in the indenture;
o we default in respect of our indebtedness for money borrowed which
results in acceleration of the maturity of $1,000,000 or more of
indebtedness, if such acceleration is not rescinded or indebtedness
discharged within 10 days after written notice to us, as provided in
the indenture; and
o certain events in bankruptcy, insolvency or reorganization involving us.
If any event of default shall happen and be continuing, the trustee or the
holders of 25% in principal amount of the outstanding new senior subordinated
debentures may declare the debentures due and payable. However, after a
declaration of acceleration has been made with respect to the new senior
subordinated debentures, but before a judgment or decree based on acceleration
has been obtained, the holders of a majority in principal amount of the
outstanding debentures may, under certain circumstances, rescind and annul such
acceleration. An event of default under the new senior subordinated debentures
may result in a cross default under Sierra's credit facility. In the event of a
default under Sierra's credit facility, Sierra's lenders may, at their option,
require us to perform on our guaranty of the credit facility. Our obligations
under the credit facility guaranty will rank senior to our obligations under the
new senior subordinated debentures.
The indenture will provide that the trustee will be under no obligation,
subject to the duty of the trustee during default to act with the required
standard of care, to exercise any of its rights or powers under the indenture at
the request or direction of any of the holders, unless such holders shall have
offered to the trustee reasonable security or indemnity against the costs,
expenses and liabilities which might be incurred by it in compliance with such
request or direction. Subject to certain conditions, the holders of a majority
in principal amount of the outstanding debentures will have the right to direct
the time, method and place of conducting any proceeding for any remedy available
to the trustee or exercising any trust or power conferred on the trustee.
The holders of a majority in principal amount of the outstanding debentures
may on behalf of the holders of all new senior subordinated debentures waive
compliance by us with certain restrictive provisions of the indenture. The
holders of a majority in principal amount of the outstanding debentures may on
behalf of the holders of new senior subordinated debentures waive certain past
defaults except a default in payment of the principal of, or premium, if any, or
interest on any new debenture or in respect of a provision which under the
indenture cannot be modified or amended without the consent of the holder of
each outstanding debenture affected thereby.
We will be required to furnish the trustee annually a statement as to any
default by it in the performance of certain covenants in the indenture.
Concerning the Trustee. The trustee may act as a depository for funds of,
make loans, which may constitute senior debt, to and perform other commercial
banking services for us in the ordinary course of business. Neither the trustee
nor any of its affiliates currently performs any commercial banking services for
us.
Old Junior Subordinated Debentures
The old junior subordinated debentures were issued under an indenture dated
September 15, 1991. The indenture is a contract between us and Chase Manhattan
Bank and Trust Company, National Association (as successor to Manufacturers
Hanover Trust Company) as trustee.
The following description is a summary of the material provisions of the
indenture relating to the old junior subordinated debentures and does not
describe the indenture in its entirety. This summary is subject to and qualified
by reference to all of the provisions in the indenture, including definitions of
certain terms used in the indenture. We urge you to read the indenture because
it, and not the summary description below, defines your rights. Copies of the
indenture will be available for inspection at the Corporate Trust Offices of the
trustee in San Francisco, California.
General. The old junior subordinated debentures are subordinated
obligations of CII Financial and are not guaranteed by Sierra. The old junior
subordinated debentures are subordinate to all our senior indebtedness,
including the new senior subordinated debentures, our guaranty of Sierra's
credit facility and the affiliate note. We are required to repay the principal
amount of the old junior subordinated debentures in full to you on September 15,
2001.
The old junior subordinated debentures bear interest, at the rate per annum
of 7 1/2%. We pay interest on the old junior subordinated debentures on March 15
and September 15 of each year, to the person in whose name the old junior
subordinated debenture (or any predecessor debenture) is registered, subject to
certain exceptions, at the close of business on March 1 or September 1, as the
case may be, before each interest payment date. Principal of, and premium, if
any, and interest on the old junior subordinated debentures are payable and the
old junior subordinated debentures are convertible and exchangeable and
transfers are registrable, at an office of the trustee or our office or agency
maintained for such purpose in San Francisco, California, provided that, at our
option, payment of interest may be made by check mailed to the address of the
person entitled thereto as it appears in the debenture register.
Conversion Rights. You may, at your option, convert any portion of the
principal amount of any old junior subordinated debenture that is an integral
multiple of $1,000 into shares of Sierra common stock at any time prior to
redemption, repurchase or maturity of the old junior subordinated debentures, at
the conversion price of $39.398 per share. Your right to convert any old junior
subordinated debentures called for redemption or to be repurchased will
terminate at the close of business on the redemption date or the repurchase
date, as the case may be, and will be lost if not exercised prior to that time.
The conversion price is subject to adjustment in certain events, including:
o dividends, and other distributions, payable in Sierra common stock on
shares of Sierra capital stock;
o the issuance to all stockholders of Sierra common stock of certain
rights, options or warrants entitling them to subscribe for or
purchase Sierra common stock at less than the then current market
price per share;
o subdivisions and combinations of Sierra common stock;
o the distribution to all holders of Sierra common stock of evidences of
debt securities of Sierra or of CII Financial, shares of any class of
capital stock, cash or assets, including securities, but excluding any
rights, options or warrants referred to above, excluding any dividend
or distribution paid exclusively in cash, and excluding any dividend
or distribution in Sierra common stock;
o distributions to all holders of Sierra common stock of cash, excluding
any cash that is distributed as part of a distribution referred to
above, in an aggregate amount that together with the aggregate amount
of certain other distributions, exceeds 10% of our market
capitalization, being the product of the current market price per
share of the Sierra common stock on the date fixed for shareholders
entitled to receive such distribution and the number of shares of
Sierra common stock outstanding on such date; and
o tender offers made by us or any of our subsidiaries for all or any
portion of Sierra common stock involving an aggregate consideration
having a fair market value on the last time, which we refer to as the
expiration time, tenders may be made pursuant to such tender offer
that, together with the aggregate amount of certain other
distributions, exceeds 5% of Sierra market capitalization on the
expiration time, being the product of the current market price per
share of the Sierra common stock on the expiration time and the number
of shares of Sierra common stock outstanding, including any tendered
shares, on the expiration time.
In addition to the foregoing adjustments, we are permitted to make such
reductions in the conversion price as we consider to be advisable in order that
any event treated for United States federal income tax purposes as a dividend of
stock or stock rights will not be taxable to the recipients. We will not be
required to make adjustments in the conversion price of less than 1% of such
price, but any adjustment that would otherwise be required to be made will be
taken into account in the computation of any subsequent adjustment.
In the case of certain consolidations or mergers to which we are a party or
the transfer of substantially all of our assets, each old junior subordinated
debenture then outstanding would, without your consent, become convertible only
into the kind and amount of securities, cash and other property receivable upon
such consolidation, merger or transfer by a holder of the number of shares of
Sierra common stock into which such old junior subordinated debenture was
convertible immediately prior to such consolidation, merger or transfer,
assuming such holder of Sierra common stock failed to exercise any rights of
election and received per share the kind and amount received per share by a
plurality of the non-electing shares.
Other than as set forth above, the conversion price is not subject to
adjustment in the event of the sale of Sierra common stock at less than market
value. If any such sale negatively affects the market price for Sierra common
stock, the value of the old junior subordinated debentures may also be adversely
affected.
Fractional shares of Sierra common stock will not be issued upon
conversion, and, in lieu thereof, we will pay cash to you based upon the market
price of the Sierra common stock. At the close of business on a record date you
will be entitled to receive the interest payable on the old junior subordinated
debentures on the corresponding interest payment date notwithstanding the
subsequent conversion thereof or our default in payment of the interest due on
such interest payment date, subject to certain provisions applicable to
defaulted interest. No payment or adjustment will be made upon conversion for
interest accrued on the old junior subordinated debentures or for dividends on
Sierra common stock issued on conversion. Therefore, old junior subordinated
debentures surrendered for conversion during the period from the close of
business on any record date to the opening of business on the corresponding
interest payment date, except old junior subordinated debentures called for
redemption, or to be repurchased, on such interest payment date or on a
redemption date or a repurchase date within such period, must be accompanied by
payment of an amount equal to the interest payable on the interest payment date.
The holder of old junior subordinated debentures on a record date who converts
old junior subordinated debentures on an interest payment date will receive the
interest and need not include a payment for any such interest upon surrender of
old junior subordinated debentures for conversion.
Subordination of Debentures. The payment of principal, any premium and
interest on the old junior subordinated debentures, including amounts payable on
any redemption or repurchase, will be subordinated to the prior payment in full
of all our senior debt. Senior debt is defined in the indenture as the principal
of, and premium, if any, and interest on all our debt, whether outstanding on
the date of the indenture or thereafter created, incurred, guaranteed or
assumed, other than:
o the old junior subordinated debentures; and
o any debt which provides, or in respect of which any instrument
creating or evidencing such debt or pursuant to which the same is
outstanding provides, that such debt is not superior in right of
payment to the new debentures.
Debt is defined in the indenture to mean:
o all debt which is (a) for money borrowed, (b) evidenced by a note,
bond or similar instrument given in connection with the acquisition of
any businesses, properties or assets of any kind, but excluding any
other trade accounts payable or accrued liabilities arising in the
ordinary course of business or (c) purchase money indebtedness with
respect to the purchase of any real or personal property or any
interest therein;
o obligations under certain leases;
o amendments, renewals, extensions, modifications and refundings of any
debt or obligations referred to above; and
o any debt or obligations referred to above in respect of which we are
liable, contingently or otherwise, to pay or advance money or property
as a guarantor, endorser or otherwise.
In August 2000, we became a guarantor of Sierra's revolving credit
facility, which at December 31, 2000 was fully drawn and had an outstanding
balance of $135 million. The old junior subordinated debentures are subordinated
to this guaranty of the credit facility debt. Our senior debt will also include
the new senior subordinated debentures to be issued in the exchange offer and
the affiliate note. The terms of our debentures do not limit our ability to
incur additional senior debt.
Upon any payment or distribution of assets to creditors as a result of a
liquidation, dissolution, winding up, reorganization for the benefit of
creditors, marshalling of assets or any bankruptcy, insolvency or similar
proceedings involving us, the holders of all senior debt will first be entitled
to receive payment in full before you will be entitled to receive any payment on
the old junior subordinated debentures. No such payment in respect of the old
junior subordinated debentures may be made if there shall have occurred and be
continuing a default in any payment with respect to any senior debt, or an event
of default in respect to any senior debt resulting in acceleration of the
maturity thereof, or if any judicial proceeding shall be pending with respect to
any such default. If the old junior subordinated debentures are declared due and
payable before their stated maturity, no payment may be made in respect of the
old junior subordinated debentures unless and until all senior debt shall have
been paid in full. For purposes of the subordination provisions, the payment,
issuance or delivery of cash, property or securities, other than our stock and
certain subordinated securities, upon conversion of an old junior subordinated
debenture, will be deemed to constitute payment on account of the principal of
such old junior subordinated debentures.
By reason of such subordination, in the event of insolvency, our creditors
who are holders of senior debt may recover more ratably than you will. The old
junior subordinated debentures are subordinate to the new senior subordinated
debentures.
The indenture permits the trustee to become our creditor and to enforce its
rights as a creditor, including rights as a holder of senior debt.
Redemption. The old junior subordinated debentures are currently redeemable
upon not less than 25 nor more than 60 days' notice by mail at any time, in
whole or in part, at our election, are currently at a redemption price equal to
100.75% of the principal amount together with accrued interest to the redemption
date, subject to the right of holders of record on regular record dates to
receive interest due on an interest payment date.
Repurchase at Option of Holders Upon Change in Control. If a change in
control as defined below occurs, you will have the right, at your option, to
require us to repurchase all of your old junior subordinated debentures not
previously called for redemption, or any portion of the principal amount
thereof, that is equal to $1,000 or an integral multiple of $1,000. The price we
are required to pay is 100% of the principal amount of the old junior
subordinated debentures to be repurchased, together with accrued interest to the
repurchase date. Such right may not be waived by our board of directors or by
the board of directors of Sierra.
At our option, instead of paying the repurchase price in cash, we may pay
the repurchase price in Sierra common stock valued at 95% of the average of the
closing prices of Sierra common stock for the five trading days ending on the
third trading day preceding the repurchase date. We may only pay the repurchase
price in Sierra common stock if such Sierra common stock is listed on a national
securities exchange or quoted on the NASDAQ National Market System at the time
of payment. Sierra has no obligation to issue shares in this event.
Within 30 days after the occurrence of a change in control, we are
obligated to mail to you notice of such change in control and of the repurchase
right arising as a result thereof. We must also deliver a copy of this notice to
the trustee and cause a copy of such notice to be published in a newspaper of
general circulation in Los Angeles, California and in the Borough of Manhattan,
The City of New York. To exercise the repurchase right, you must deliver to the
trustee the old junior subordinated debentures with respect to which the
repurchase right is being exercised, duly endorsed for transfer to us. We are
required to repurchase the old junior subordinated debentures on the date that
is 45 days after the date of our notice, which we refer to as the repurchase
date. At least two trading days prior to the repurchase date, we must publish a
notice in the manner described above specifying whether we will pay the
repurchase price in cash or in Sierra common stock.
A change in control will be deemed to have occurred at the time after the
old junior subordinated debentures are issued that any person, including any
syndicate or group deemed to be a "Person" under Section 13(d)(3) of the
Exchange Act, is or becomes the beneficial owner, directly or indirectly,
through a purchase, merger or other acquisition transaction or series of
transactions, of shares of our capital stock entitling such person to exercise
50% or more of the total voting power of all shares of our capital stock that
are entitled to vote in elections of directors. For purposes of these
provisions, whether a person is a "beneficial owner" will be determined in
accordance with Rule l3d-3 promulgated by the SEC under the Exchange Act as in
effect on the date of execution of the indenture.
However, a change in control will not be deemed to have occurred if either
(a) the closing price per share of Sierra common stock for any five trading days
within a period of 10 consecutive trading days ending immediately before the
change in control shall equal or exceed 105% of the conversion price in effect
on each of those trading days, or (b) all of the consideration (excluding cash
payments for fractional shares) in the transaction or transactions constituting
the change in control consists of shares of common stock traded on a national
securities exchange or quoted on the NASDAQ National Market System and as a
result of such transaction or transactions the old junior subordinated
debentures become convertible solely into such common stock.
Rule 13e-4 under the Exchange Act requires the dissemination of certain
information to security holders in the event of an issuer tender offer and may
apply in the event that the repurchase option becomes available to you. We will
comply with this rule to the extent it applies at that time.
Merger and Consolidation. The indenture provides that we may consolidate
with or merge into any other corporation, or convey, transfer or lease its
properties and assets substantially as an entirety to any person, provided that
in any such case:
o the successor corporation assumes by a supplemental indenture our and
Sierra's obligations under the
indenture,
o immediately after giving effect to such transaction, no default will have
occurred and be continuing, and
o we deliver to the trustee an officer's certificate and an opinion of
counsel stating that the terms of the indenture with respect to such
event have been complied with.
Upon compliance with these provisions by a successor corporation, we,
except in the case of a lease, would be relieved of our obligations under the
indenture and the old junior subordinated debentures.
Modification of the Indenture. Modifications and amendments of the
indenture may be made by us and the trustee with the consent of the holders of a
majority in principal amount of the outstanding debentures. However, none of the
following modifications or amendments may be made without your consent:
o change the stated maturity date of the principal of, or any installment
of interest on, the old junior subordinated debentures;
o reduce the principal amount of, any interest on, or premium payable on
redemption of, any old junior subordinated debenture;
o change the place or currency of payment on the old junior subordinated
debentures;
o impair your right to institute suit for the enforcement of any payment on
the old junior subordinated debentures when due;
o adversely affect your right to convert the old junior subordinated
debentures into Sierra common stock;
o modify the provisions of the indenture with respect to the subordination
of the old junior subordinated debentures in a manner adverse to you; or
o reduce the percentage in principal amount of old junior subordinated
debentures the consent of whose holders is required for modification
or amendment of the indenture or for waiver of compliance with certain
provisions of the indenture or for waiver of certain defaults.
Events of Default, Notice and Waiver. The following are events of default
under the indenture:
o we fail to make a payment of interest on the old junior subordinated
debentures due, and this failure continues for 30 days;
o we fail to make the payment of principal or premium, if any, on the old
junior subordinated debentures, when due;
o we fail in the performance of any other covenant and this failure
continues for 60 days after written notice, as provided in the indenture;
o we default in respect of our indebtedness for money borrowed which
results in acceleration of the maturity of $1,000,000 or more of
indebtedness, if such acceleration is not rescinded or indebtedness
discharged within 10 days after written notice to us, as provided in
the indenture; and
o certain events in bankruptcy, insolvency or reorganization involving us.
If any event of default shall happen and be continuing, the trustee or the
holders of 25% in principal amount of the outstanding debentures may declare the
old junior subordinated debentures due and payable. However, after a declaration
of acceleration has been made with respect to the old junior subordinated
debentures, but before a judgment or decree based on acceleration has been
obtained, the holders of a majority in principal amount of the outstanding
debentures may, under certain circumstances, rescind and annul such
acceleration.
The indenture will provide that the trustee will be under no obligation,
subject to the duty of the trustee during default to act with the required
standard of care, to exercise any of its rights or powers under the indenture at
the request or direction of any of the holders, unless such holders shall have
offered to the trustee reasonable security or indemnity against the costs,
expenses and liabilities which might be incurred by it in compliance with such
request or direction. Subject to certain conditions, the holders of a majority
in principal amount of the outstanding debentures will have the right to direct
the time, method and place of conducting any proceeding for any remedy available
to the trustee or exercising any trust or power conferred on the trustee.
The holders of a majority in principal amount of the outstanding debentures
may on behalf of the holders of all old junior subordinated debentures waive
compliance by us with certain restrictive provisions of the indenture. The
holders of a majority in principal amount of the outstanding debentures may on
behalf of the holders of old junior subordinated debentures waive certain past
defaults except a default in payment of the principal of, or premium, if any, or
interest on any old junior subordinated debenture or in respect of a provision
which under the indenture cannot be modified or amended without the consent of
the holder of each outstanding debenture affected thereby.
We will be required to furnish the trustee annually a statement as to any
default by it in the performance of certain covenants in the indenture.
Concerning the Trustee. The trustee may act as a depository for funds of,
make loans, which may constitute senior debt, to and perform other commercial
banking services for us or for us in the ordinary course of business. The
trustee is one of the lenders under Sierra's credit facility.
BOOK-ENTRY SYSTEM -- THE DEPOSITORY TRUST COMPANY
The new senior subordinated debentures will be evidenced by a global
security initially deposited with The Depository Trust Company, or DTC, and
registered in the name of Cede & Co., as DTC's nominee. Except as set forth
below, the global security may be transferred only to another nominee of DTC or
to a successor of DTC or its nominee.
Holders of the new senior subordinated debentures may hold their interests
in the global security directly through DTC or indirectly through organizations
which are participants in DTC, called "participants". Transfers between
participants will be affected in the ordinary way in accordance with DTC rules
and will be settled in clearinghouse funds. The laws of some states require that
some persons take physical delivery of securities in definitive form. As a
result, holders may be unable to transfer beneficial interests in the global
security to those persons.
Holders that are not participants may beneficially own interests in the
global security held by DTC only through participants or indirect participants,
including banks, brokers, dealers, trust companies and other parties that clear
through or maintain a custodial relationship with a participant. So long as Cede
& Co., as the nominee of DTC, is the registered owner of the global security,
Cede & Co. will be considered the sole holder of the global security for all
purposes. Except as provided below, owners of beneficial interests in the global
security will not:
o be entitled to have certificates registered in their names;
o be entitled to receive physical delivery of certificates in definitive
form; and
o be considered registered holders.
We will make payments of interest on and principal of and the redemption or
repurchase price of the global security to Cede & Co., the nominee for DTC, as
the registered holder of the global security. We will make these payments by
wire transfer of immediately available funds. Neither we, the trustee nor any
paying agent will have any responsibility or liability for:
o records or payments on beneficial ownership interests in the global
security; or
o maintaining, supervising or reviewing any records relating to those
beneficial ownership interests.
We have been informed that DTC's practice is to credit participants'
accounts on the payment date. These payments will be made in amounts
proportionate to participants' beneficial interests in the new senior
subordinated debentures. Payments by participants to owners of beneficial
interests in the new senior subordinated debentures represented by the global
security held through participants will be the responsibility of those
participants.
We will send any redemption notices to Cede & Co. We understand that if
less than all of the new senior subordinated debentures are being redeemed,
DTC's practice is to determine by lot the amount of the holdings of each
participant to be redeemed. We also understand that neither DTC nor Cede & Co.
will consent or vote with respect to the new senior subordinated debentures. We
have been advised that under its usual procedures, DTC will mail an "omnibus
proxy" to us as soon as possible after the record date. The omnibus proxy
assigns Cede & Co.'s consenting or voting rights to those participants to whose
accounts the exchange notes are credited on the record date identified in a
listing attached to the omnibus proxy.
A person having a beneficial interest in new senior subordinated debentures
represented by the global security may be unable to pledge that interest to
persons or entities that do not participate in the DTC system, or to take other
actions in respect of that interest, because that interest is not represented by
a physical certificate.
DTC has advised us that it is:
o a limited purpose trust company organized under the laws of the State of
New York;
o a member of the Federal Reserve System;
o a "clearing corporation" within the meaning of the Uniform Commercial
Code, and
o a "clearing agency" registered pursuant to the provisions of Section 17A
of the Exchange Act.
DTC was created to hold securities for its participants and to facilitate
the clearance and settlement of securities transactions between participants
through electronic book-entry changes to accounts of its participants. Some of
the participants, together with other entities, own DTC. Indirect access to the
DTC system is available to others such as banks, brokers, dealers and trust
companies that clear through, or maintain a custodial relationship with a
participant, either directly or indirectly.
DTC is under no obligation to perform or continue to perform the above
procedures. DTC may discontinue these at any time. If DTC is at any time
unwilling or unable to continue as depository and a successor depository is not
appointed by us within 90 days, we will cause new senior subordinated debentures
to be issued in definitive form in exchange for the global security.
MATERIAL UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following discussion summarizes the material United States federal
income tax consequences to us and to United States holders of the exchange offer
and of the acquisition, ownership and disposition of the new senior subordinated
debentures. A United States holder is (1) an individual citizen or resident of
the United States or (2) a corporation created or organized in or under the laws
of the United States or any political subdivision thereof.
This discussion does not purport to describe all of the tax considerations
that may be relevant to a holder of old junior subordinated debentures. The
following summary deals only with old junior subordinated debentures that are,
and new senior subordinated debentures that will be, held as capital assets by
United States holders, and does not deal with persons that are subject to
special tax rules, such as:
o dealers or traders in securities or currencies;
o financial institutions or other United States holders that treat
income in respect of the old junior subordinated debentures or new
senior subordinated debentures as financial services income;
o insurance companies;
o tax-exempt entities;
o persons holding old junior subordinated debentures or new senior
subordinated debentures as a part of a straddles, conversion
transaction or other arrangement involving more than one position;
o persons that have a principal place of business or "tax home" outside the
United States; or
o persons whose "functional currency" is not the U.S. dollar.
The discussion below is based upon the provisions of the United States Internal
Revenue Code of 1986, as amended, and regulations, rulings and judicial
decisions thereunder as of the date of this prospectus; any of these authorities
may be repealed, revoked or modified, perhaps with retroactive effect, so as to
result in United States federal income tax consequences different from those
discussed below. The statements of law and legal conclusions set out below
regarding material tax consequences to us and United States holders of the
exchange offer are the opinion of Morgan, Lewis & Bockius LLP, our special
United States tax counsel. However, opinions of tax counsel are not binding on
United States tax authorities or courts.
Because United States tax consequences may differ from one holder to the
next, the discussion set out below does not purport to describe all of the tax
considerations that may be relevant to you and your particular situation.
Accordingly, you are advised to consult your own tax advisor as to the United
States federal, state, local and other tax consequences of the exchange offer
and of the acquisition, ownership and disposition of new senior subordinated
debentures. The statements of United States tax law set out below are based on
the laws and interpretations in force as of the date of this prospectus, and are
subject to any changes occurring after that date.
Tax Consequences to Us
A corporation will recognize cancellation of indebtedness income upon the
satisfaction of its indebtedness for an amount that is less than the amount of
the indebtedness. If the exchange offer is consummated, then we will realize
ordinary income from (1) the payment of cash in satisfaction of the old junior
subordinated debentures to the extent that the adjusted issue price, which is
the stated principal amount, of the old junior subordinated debentures
extinguished exceeds the amount of cash paid and (2) the exchange of new senior
subordinated debentures for old junior subordinated debentures to the extent
that the adjusted issue price of the old junior subordinated debentures exceeds
the issue price of the new senior subordinated debentures exchanged therefor. As
discussed more fully below, the issue price of a new senior subordinated
debenture probably will equal the stated principal amount of the new senior
subordinated debenture, in which case no cancellation of indebtedness income
will arise from the exchange of new senior subordinated debenture for the old
junior subordinated debenture. No assurance can be given in this respect,
however, and it is possible that the issue price will equal the fair market
value of the new senior subordinated debenture or of the old junior subordinated
debenture exchanged therefor, in which case we would probably recognize
cancellation of indebtedness income with respect to the exchange of new senior
subordinated debentures for old junior subordinated debentures (See paragraph 3.
under --Tax Consequences to United States Holders of the Exchange
Offer--Exchange of New Senior Subordinated Debentures for Old Junior
Subordinated Debentures--The Exchange).
Tax Consequences to United States Holders of the Exchange Offer
Your tax consequences will depend on the option that you select. The
discussion under each of the headings below describes the tax consequences
applicable to each option under the exchange offer: receiving cash in
satisfaction of your old junior subordinated debentures, exchanging your old
junior subordinated debentures for new senior subordinated debentures or
continuing to hold your old junior subordinated debentures.
Receipt of Cash for Old Junior Subordinated Debentures
A United States holder that receives cash under the exchange offer will
recognize gain or loss in an amount equal to the difference between (1) the
amount of cash received and (2) the adjusted tax basis of the old junior
subordinated debentures in the hands of the United States holder. Except as
discussed below, the gain or loss recognized by a United States holder will be
treated as capital gain or loss and will be long-term capital gain or loss if
the old junior subordinated debentures have been held for more than one year.
Gain recognized by a United States holder will be treated as ordinary income, to
the extent of any market discount on the old junior subordinated debentures that
has accrued during the period that the United States holder held the old junior
subordinated debentures and that has not previously been included in income by
the United States holder. A United States holder also will recognize ordinary
income in an amount equal to the cash payments received as payment of the
interest that has accrued on the old junior subordinated debentures.
Exchange of New Senior Subordinated Debentures for Old Junior Subordinated
Debentures
The Exchange
The exchange of new senior subordinated debentures for old junior
subordinated debentures pursuant to the exchange offer may be treated as a
taxable exchange or as a reorganization and recapitalization, within the meaning
of Section 368(a)(1)(E) of the Internal Revenue Code. An exchange of new senior
subordinated debentures for old junior subordinated debentures will be treated
as a recapitalization only if both the old junior subordinated debentures and
the new senior subordinated debentures are treated as "securities" for purposes
of the reorganization provisions of the Internal Revenue Code. The term
"securities" is not defined in the Internal Revenue Code or in the regulations
promulgated thereunder. Under applicable administrative pronouncements and
judicial decisions, as a general proposition, the original term of a debt
instrument is the most important factor in determining whether the debt
instrument is a security: debt instruments with an original term of at least ten
years usually being considered securities and debt instruments with a term of
five years or less usually not being considered securities. However, (1) the
term of a debt instrument is not necessarily determinative, and other factors
such as the degree of participation and continuing interest associated with the
debt instrument may be relevant, (2) even under this simplified original-term
test, the status of debt instruments with an original term of between five and
ten years, such as the new senior subordinated debentures, is not clear, and (3)
in any event, the applicable judicial decisions are not entirely consistent.
Accordingly, there can be no assurance that the Internal Revenue Service (IRS)
or a court will agree that the new senior subordinated debentures properly are
treated as securities. If the new senior subordinated debentures that a United
States Holder receives are not treated as securities then the exchange will be
treated as a taxable transaction, rather than as a recapitalization. You are
encouraged to consult your own tax advisor as to whether an exchange of new
senior subordinated debentures for old junior subordinated debentures will be
treated as a recapitalization.
The exchange should have the following United States federal income tax
consequences:
1. An exchanging United States holder of old junior subordinated
debentures should realize gain or loss in an amount equal to the
difference between (1) the issue price of the new senior subordinated
debentures received and (2) the adjusted tax basis of the old junior
subordinated debentures in the hands of the United States holder. The
amount of gain or loss realized, as opposed to the amount of gain or
loss recognized, does not depend on whether the exchange is treated as
a taxable exchange or as a recapitalization. A United States holder
also will recognize ordinary income in an amount equal to the cash
payments received in satisfaction of interest that has accrued on the
old junior subordinated debentures.
2. The issue price of the new senior subordinated debentures will depend
upon whether the new senior subordinated debentures or the old junior
subordinated debentures are "traded on an established market" at any
time within the 60-day period ending 30 days after the issue date of
the new senior subordinated debentures. For this purpose, a debt
instrument is considered to be traded on an established market, if (1)
the debt instrument is listed on a national securities exchange, an
interdealer quotation system sponsored by a national securities
association or a designated foreign exchange or board of trade, (2) the
debt instrument is traded either on a board of trade designated as a
contract market by the Commodities Futures Trading Commission or on an
interbank market, (3) the debt instrument appears on a "quotation
medium,"which is a system of general circulation that provides a
reasonable basis to determine fair market value by disseminating either
recent price quotations of one or more identified brokers, dealers or
traders or actual prices of recent sales transactions, or (4) price
quotations for the debt instrument otherwise are readily available from
dealers, brokers or traders. We do not believe that the old junior
subordinated debentures have been traded on an established securities
market. Because we will not list the new senior subordinated debentures
on the New York Stock Exchange until after 30 days following the issue
date of the new senior subordinated debentures, the new senior
subordinated debentures should not be treated as traded on an
established securities market within 30 days after their issue date,
except in the unlikely event that a significant amount of trading takes
place off the Exchange within this 30-day period.
3. If neither the new senior subordinated debentures nor the old junior
subordinated debentures are traded on an established market, then the
issue price of the new senior subordinated debentures will be equal to
their stated principal amount ($1000 per new senior subordinated
debenture). If the new senior subordinated debentures are traded on an
established market, then the issue price of the new senior subordinated
debentures will be their fair market value on the issue date. If the
old junior subordinated debentures are, and the new senior subordinated
debentures are not, traded on an established market, then the issue
price of the new senior subordinated debentures will be the fair market
value on the issue date of the old junior subordinated debentures
surrendered in exchange therefor.
4. If the exchange made by an exchanging United States holder is treated
as a recapitalization, then gain or loss, if any, realized by the
United States holder will not be recognized.
5. If the exchange made by an exchanging United States holder is treated
as a taxable exchange, then gain, if any, realized by the United States
holder will be recognized. Loss, if any, realized by the exchanging
United States holder will be recognized only to the extent permitted
under the wash sale rules of Section 1091 of the Internal Revenue Code.
You are advised to consult your own tax advisor as to the potential
application of the wash sale rules.
6. Except as discussed below, gain or loss recognized by an exchanging
United States holder of old junior subordinated debentures will be
treated as capital gain or loss. Gain recognized by an exchanging
United States holder will be treated as ordinary income, to the extent
of any market discount on the old junior subordinated debentures that
has accrued during the period that the exchanging United States holder
held the old junior subordinated debentures and that has not previously
been included in income by the United States holder. An old junior
subordinated debenture generally will be considered to have been
acquired with market discount if the issue price of the old junior
subordinated debenture at the time of acquisition exceeded the initial
tax basis of the old junior subordinated debenture in the hands of the
United States holder by more than a specified de minimis amount. Market
discount accrues on ratable basis, unless the United States holder
elects to accrue the market discount using a constant-yield method. If
the exchange made by an exchanging United States holder is treated as a
recapitalization, then any accrued market discount on the old junior
subordinated debentures that is not recognized on the exchange will be
transferred to the new senior subordinated debentures received.
7. If the exchange made by an exchanging United States holder is treated
as a recapitalization, then the tax basis of the new senior
subordinated debentures received in the hands of the United States
holder will be equal to the adjusted tax basis of the old junior
subordinated debentures transferred in the exchange. The holding period
of the new senior subordinated debentures will include the holding
period of the old junior subordinated debentures surrendered in the
exchange.
8. If the exchange made by an exchanging United States holder is treated
as a taxable exchange, then the tax basis of the new senior
subordinated debentures received in the hands of the United States
holder will be equal to their issue price. The holding period of the
new senior subordinated debentures will not include the holding period
of the old junior subordinated debentures surrendered in the exchange.
Tax Treatment of the New Senior Subordinated Debentures
Stated Interest
Interest on a new senior subordinated debenture, other than interest that
is not "qualified stated interest," will be taxable to a United States holder as
ordinary interest income at the time that the interest is received or is
accrued, in accordance with the United States holder's method of accounting for
federal income tax purposes. In general, qualified stated interest is stated
interest that is unconditionally payable at least annually at a single fixed
rate during the entire term of a debt obligation.
Original Issue Discount
General. Whether the new senior subordinated debentures are issued with
original issue discount (OID) will depend upon whether the issue price of the
new senior subordinated debentures is calculated with respect to their issue
price or their fair market value. If, as discussed above, the issue price of the
new senior subordinated debentures is equal to their principal amount, then the
new senior subordinated debentures would not be treated as issued with OID and
the rest of the discussion under this heading "--Original Issue Discount" would
not be applicable to the new senior subordinated debentures. If, on the other
hand, the issue price of the new senior subordinated debentures is based on the
fair market value of the new senior subordinated debentures or the old junior
subordinated debentures, then the new senior subordinated debentures probably
would be treated as issued with OID. The amount of OID on a new senior
subordinated debenture will be equal to the excess of (1) the stated redemption
price at maturity of the new senior subordinated debenture over (2) the issue
price of the new senior subordinated debenture, determined in the manner
described above. The stated redemption price at maturity of a new senior
subordinated debenture is the sum of all payments on the new senior subordinated
debenture other than payments of qualified stated interest.
Subject to the discussion below under "-Acquisition Premium," a United
States holder of a new senior subordinated debenture issued with OID must
include OID in income, as ordinary interest income, as it accrues, on a
constant-yield basis, before the receipt of cash attributable to this income,
and will be required to include in income increasingly greater amounts of OID
over the life of the new senior subordinated debenture. The amount of OID
includible in income by a United States holder is the sum of the daily portions
of OID with respect to the new senior subordinated debenture for each day during
the taxable year or portion of the taxable year on which the United States
holder holds the new senior subordinated debenture, known as accrued OID. The
daily portion is determined by allocating to each day in any "accrual period" a
pro rata portion of the OID allocable to that accrual period. Accrual periods
with respect to a new senior subordinated debenture may be of any length
selected by the United States holder and may vary in length over the term of the
new senior subordinated debenture, so long as (1) no accrual period is longer
than one year and (2) each scheduled payment of interest or principal on the new
senior subordinated debenture occurs on either the final or first day of an
accrual period. The amount of OID allocable to an accrual period is equal to the
excess of (1) the product of the adjusted issue price of the new senior
subordinated debenture at the beginning of the accrual period and the yield to
maturity of the new senior subordinated debenture, determined on the basis of
compounding at the close of each accrual period and properly adjusted for the
length of the accrual period, over (2) the sum of the payments of qualified
stated interest on the new senior subordinated debenture that are allocable to
the accrual period. The "adjusted issue price" of a new senior subordinated
debenture at the beginning of any accrual period is the issue price of the new
senior subordinated debenture, increased by the amount of accrued OID for all
prior accrual periods and decreased by the amount of any payments previously
made on the new senior subordinated debenture other than payments of qualified
stated interest. The amount of OID allocable to an initial short accrual period
may be computed using any reasonable method, if all other accrual periods other
than a final short accrual period are of equal length. The amount of OID
allocable to the final accrual period is the difference between the amount
payable at the maturity of the new senior subordinated debenture and the new
senior subordinated debenture's adjusted issue price as of the beginning of the
final accrual period.
In general, the effect of the OID provisions described above is that United
States holders will realize interest income on the new senior subordinated
debentures on a constant-yield basis over the term of the new senior
subordinated debentures; United States holders generally will not realize
additional income on the receipt of payments, other than payments of qualified
stated interest, on the new senior subordinated debentures, even if those
payments are denominated as interest.
Acquisition Premium. A United States holder that acquires a new senior
subordinated debenture for an amount less than or equal to the sum of all
amounts payable on the new senior subordinated debenture after the acquisition
date, other than payments of qualified stated interest, but in excess of its
adjusted issue price (this excess being "acquisition premium") and that does not
make the election described below under "Election To Treat All Interest As
Original Issue Discount," is permitted to reduce the daily portions of OID
includible in its income. The amount of this reduction is calculated by
multiplying the daily portion of OID by a fraction, the numerator of which is
the excess of the United States holder's adjusted tax basis in the new senior
subordinated debenture immediately after its acquisition over the adjusted issue
price of the new senior subordinated debenture, and the denominator of which is
the excess of the sum of all amounts payable on the new senior subordinated
debenture after the acquisition date, other than payments of qualified stated
interest, over the adjusted issue price of the new senior subordinated
debenture. The ability to reduce OID inclusions to reflect acquisition premium
in the manner described above is specifically available to a United States
holder (1) that acquires new senior subordinated debentures with OID pursuant to
the exchange offer in a transaction treated as a recapitalization and (2) that
realizes a loss on the exchange that it is not permitted to recognize under the
recapitalization rules, with the consequence that its initial tax basis in the
new senior subordinated debentures exceeds the adjusted issue price of those
debentures.
Election To Treat All Interest as Original Issue Discount. A United States
holder may elect to include in gross income all interest that accrues on a new
senior subordinated debenture using the constant-yield method described above
under the heading "Original Issue Discount -General," with the modifications
described below. For purposes of this election, interest includes stated
interest, OID, market discount and de minimis market discount, as adjusted by
any acquisition premium.
In applying the constant-yield method to a new senior subordinated
debenture with respect to which this election has been made, the issue price of
the new senior subordinated debenture will equal the electing United States
holder's adjusted basis in the new senior subordinated debenture immediately
after its acquisition, the issue date of the new senior subordinated debenture
will be the date of its acquisition by the electing United States holder and no
payments on the new senior subordinated debenture will be treated as payments of
qualified stated interest. This election generally will apply only to the new
senior subordinated debenture with respect to which it is made and may not be
revoked without the consent of the IRS. If the election to apply the
constant-yield method to all interest on a new senior subordinated debenture is
made with respect to a market discount debenture, then the electing United
States holder will be treated as having made the election discussed below under
"Market Discount" to include market discount in income currently over the life
of all debt instruments held or thereafter acquired by the United States holder.
Market Discount
A new senior subordinated debenture will be considered to be a market
discount debenture if the adjusted issue price of the new senior subordinated
debenture at the time of acquisition exceeds the initial tax basis of the new
senior subordinated debenture in the hands of the United States holder by more
than a specified de minimis amount. If this excess is not sufficient to cause
the new senior subordinated debenture to be a market discount debenture, this
excess constitutes "de minimis market discount." In addition, as discussed above
under "Exchange of New Senior Subordinated Debentures for Old Junior
Subordinated Debentures-The Exchange," if a United States holder acquires new
senior subordinated debentures pursuant to the exchange offer in an exchange
treated as a recapitalization, then accrued market discount on an old junior
subordinated debenture that is not taken into account in connection with the
exchange will carry over to the new senior subordinated debenture received in
exchange.
Any gain recognized on the receipt of payments on or disposition of a
market discount debenture will be treated as ordinary income to the extent that
this gain does not exceed the accrued market discount on the new senior
subordinated debenture. Alternatively, a United States holder of a market
discount debenture may elect to include market discount in income currently over
the life of the new senior subordinated debenture. This election shall apply to
all debt instruments with market discount acquired by the electing United States
holder on or after the first day of the first taxable year to which the election
applies. This election may not be revoked without the consent of the IRS. A
United States holder that makes the election described under "Original Issue
Discount-Election To Treat All Interest as Original Issue Discount" will be
deemed to have elected to include market discount in income currently.
Market discount on a market discount debenture will accrue on a ratable
basis unless the United States holder elects to accrue this market discount
using a constant-yield method. This election shall apply only to the new senior
subordinated debenture with respect to which it is made and may not be revoked
without the consent of the IRS. A United States holder of a market discount
debenture that does not elect, and is not deemed to have elected, to include
market discount in income currently generally will be required to defer
deductions for net direct interest expense with respect to the new senior
subordinated debenture (defined for each taxable year as the excess of interest
expense allocable to the new senior subordinated debenture over interest,
including OID, includible in income in respect of the new senior subordinated
debenture) in an amount not exceeding the accrued market discount on the new
senior subordinated debenture until the maturity or disposition of the new
senior subordinated debenture.
Purchase, Sale and Retirement of New Senior Subordinated Debentures
A United States holder's initial tax basis in a new senior subordinated
debenture, determined in the manner described above under "Exchange of New
Senior Subordinated Debentures for Old Junior Subordinated Debentures-The
Exchange," will be increased by the amount of any OID or market discount
included in the United States holder's income with respect to the new senior
subordinated debenture and reduced by the amount of any payments on the new
senior subordinated debenture other than payments of qualified stated interest.
A United States holder generally will recognize gain or loss on the sale or
retirement of a new senior subordinated debenture in an amount equal to the
difference between the amount realized on the sale or retirement, other than
amounts attributable to accrued but unpaid interest, which will be taxable as
ordinary income, and the tax basis of the new senior subordinated debenture.
Except to the extent described above under "-Market Discount," gain or loss
recognized on the sale or retirement of a new senior subordinated debenture will
be capital gain or loss and will be long-term capital gain or loss if the new
senior subordinated debenture has been held for more than one year.
Nonparticipation in the Exchange Offer
A United States holder that does not participate in the exchange offer and
instead retains its old junior subordinated debentures will not recognize any
gain or loss as a result of the consummation of the exchange offer.
LEGAL MATTERS
The validity of our new senior subordinated debentures offered by this
prospectus will be passed upon for us by Morgan, Lewis & Bockius LLP, New York,
New York.
EXPERTS
The financial statements and related financial statement schedule of CII
Financial, Inc. and subsidiaries as of December 31, 1999 and 1998, and for each
of the three years in the period ended December 31, 1999, included in this
prospectus have been audited by Deloitte & Touche LLP, independent auditors, as
stated in their report appearing herein, and have been so included in reliance
upon the reports of such firm given upon their authority as experts in
accounting and auditing.
ANNEX I
GLOSSARY OF SELECTED INSURANCE TERMS
The following terms when used in this Prospectus have the following meanings:
Assume.............................. To receive from a ceding company, all or
a portion of a risk in consideration
of a premium.
Cede................................. To transfer to a reinsurer, all or a
portion of a risk in consideration of a
premium.
Combined ratio..................... The sum of the
loss ratio, the underwriting expense ratio
and the policyholders' dividend ratio,
expressed as a percentage. A combined ratio
less than 100% indicates an underwriting
profit.
Direct written premiums......... Premiums written by an insurer before the
assumption and cession of reinsurance.
Loss ratio........................... The ratio arrived at by dividing the
amount of losses and loss adjustment expenses by net earned premiums.
Losses ........................... For workers' compensation insurance,
payments and reserves needed to provide indemnity, medical and rehabilitation
costs to injured workers.
Loss adjustment expenses...... The expenses of settling claims, including
legal, other fees and general expenses.
Net earned premiums............ The portion of premiums applicable to the
expired period of policies after the assumption and cession of reinsurance.
Net written premiums............ Premiums retained by an insurer after the
assumption and cession of reinsurance.
Participating policy............... An insurance policy where the
policyholders may receive a "dividend" which is a partial return of premium,
after the policy period if, among other factors, the insured has had a favorable
claims history during the period; that is, the policyholder "participates" in
the savings resulting from a favorable claims history, among other factors.
Policy acquisition costs......... Agents' and brokers' commissions, premium
taxes, boards and bureau fees, marketing, underwriting and other direct expenses
associated with acquiring and retaining business.
Policyholders' dividend ratio... The ratio arrived at by dividing the
amount of policyholders' dividends incurred by net earned premiums.
Policyholders' surplus............ The sum remaining after all liabilities
are subtracted from all assets, applying statutory accounting principles. This
sum is regarded as financial protection to policyholders in the event an
insurance company suffers unexpected or catastrophic losses.
Quota share reinsurance......... A form of reinsurance in which the
reinsurer assumes an agreed percentage of certain risks insured by the ceding
insurer up to a specified amount, and shares premiums and losses
proportionately.
Reinsurance........................ An agreement whereby an original
insurer remits a portion of the premium to a reinsurer as payment for the
reinsurers assumption of a portion of the risk. Reinsurance can be effected by
"treaties," where a reinsurance treaty automatically covers all risks of a
defined category, amount and type, or by "facultative reinsurance." Facultative
reinsurance is negotiated between an original insurer and the reinsurer on an
individual, contract-by-contract basis.
Reserves or loss reserves......... A balance sheet liability for unpaid
losses representing estimates of amounts needed to pay reported and unreported
claims and related loss adjustment expenses.
Statutory accounting............... Recording transactions and preparing
financial statements in accordance with the rules and procedures adopted by
regulatory authorities, generally reflecting a liquidating, rather than a going
concern, concept of accounting.
Treaty.............................. See Reinsurance.
Unassigned funds..................... The cumulative amount of retained net
profits from insurance operations, or earned surplus including investment
income, as determined under statutory accounting principles.
Underwriting..................... The process whereby an insurer reviews
applications submitted for insurance coverage and determines whether it will
accept all or part, and at what premium, of the coverage being requested.
Underwriting expenses............ The aggregate of policy acquisition costs
and the portion of administrative, general and other expenses attributable to
insurance operations.
Underwriting expense ratio...... For generally accepted accounting
principles ("GAAP"), the ratio arrived at by dividing the amount of GAAP
underwriting expenses by net earned premiums. For statutory accounting basis,
the ratio arrived at by dividing the amount of statutory underwriting expenses
by net written premiums.
Underwriting profit (loss)...... The amount of net income (loss) from
insurance operations, exclusive of net investment or other income.
F-3
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CII Financial, Inc. and Subsidiaries Page
Management Report on Consolidated Financial Statements F-2
Report of Independent Auditors F-3
Consolidated Financial Statements for the Nine Months
Ended September 30, 2000 and 1999(unaudited), and the Years Ended December
31, 1999, 1998 and 1997:
Consolidated Balance Sheets F-4
Consolidated Statements of Operations F-5
Consolidated Statements of Stockholder's Equity F-6
Consolidated Statements of Cash Flows F-7
Notes to Consolidated Financial Statements F-8
Supplemental Financial Statement Schedule F-24
MANAGEMENT REPORT ON CONSOLIDATED FINANCIAL STATEMENTS
The management of CII Financial, Inc. is responsible for the integrity and
objectivity of the accompanying consolidated financial statements. The
statements have been prepared in conformity with accounting principles generally
accepted in the United States of America applied on a consistent basis and are
not misstated due to fraud or material error. The statements include some
amounts that are based upon the Company's best estimates and judgment.
The accounting systems and controls of the Company are designed to provide
reasonable assurance that transactions are executed in accordance with
management's authorization, that the financial records are reliable for
preparing financial statements and maintaining accountability for assets, and
that assets are safeguarded against losses from unauthorized use or disposition.
Management believes that for the year ended December 31, 1999, such systems and
controls were adequate to meet the objectives discussed herein.
The accompanying consolidated financial statements have been audited by
independent certified public accountants, whose audits thereof were made in
accordance with auditing standards generally accepted in the United States of
America and included a review of internal accounting controls to the extent
necessary to design audit procedures aimed at gathering sufficient evidence to
provide a reasonable basis for their opinion on the fairness of presentation of
the consolidated financial statements taken as a whole.
Kathy Marlon,
Chairman and
Chief Executive Officer
John F. Okita
Chief Financial Officer
Report of Independent Auditors
To the Board of Directors and Stockholder
CII Financial, Inc.
Las Vegas, Nevada
We have audited the accompanying consolidated balance sheets
of CII Financial, Inc. and Subsidiaries as of December 31, 1999 and 1998 and the
related consolidated statements of operations, stockholder's equity, and cash
flows for each of the three years in the period ended December 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States of America. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the consolidated financial
position of CII Financial, Inc. and Subsidiaries at December 31, 1999 and 1998
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 1999 in conformity with
accounting principles generally accepted in the United States of America.
Our audits were conducted for the purpose of forming an
opinion on the basic consolidated financial statements taken as a whole. The
supplemental schedule listed in the index to the consolidated financial
statements is presented for the purpose of additional analysis and is not a
required part of the basic consolidated financial statements. This schedule is
the responsibility of the management of CII Financial, Inc. Such schedule has
been subjected to the auditing procedures applied in our audits of the basic
consolidated financial statements and, in our opinion, is fairly stated in all
material respects when considered in relation to the basic consolidated
financial statements taken as a whole.
/s/ DELOITTE & TOUCHE, LLP
Las Vegas, Nevada
December 21, 2000
(except for Note 12, as to which the date is December 28, 2000)
CII FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands except for share data)
September 30, December 31,
2000 1999 1998
---- ---- ----
(Unaudited)
ASSETS
Invested assets:
Debt securities, available-for-sale, at fair value $164,660 $165,296 $185,644
Debt securities, held-to-maturity, at amortized cost 22,154 25,023 53,967
Preferred stock, at fair value 1,732 3,486 882
---------- ---------- ----------
Mortgage loans on non-affiliated real estate 6,281 6,416 11,635
----------- ----------- ---------
Total invested assets 194,827 200,221 252,128
--------- --------- --------
Cash and cash equivalents 19,408 16,833 22,114
Reinsurance recoverable 211,594 131,862 58,424
Premiums receivable (net of allowances of $1,134 (unaudited),
$1,134 and 1,278) 13,402 9,391 10,612
Investment income receivable 2,406 2,786 2,782
Deferred policy acquisition costs 2,732 2,378 1,804
Mortgage loans on affiliated real estate 10,261 2,959 3,082
Real estate limited partnership 7,108 6,559 6,185
Federal income taxes receivable 9,478 4,896 492
Deferred income taxes 15,984 17,344 15,929
Property and equipment, net 5,097 8,354 5,253
Other assets 555 755 1,075
------------ ------------ -----------
TOTAL ASSETS $492,852 $404,338 $379,880
======== ======== ========
LIABILITIES
Reserve for loss and loss adjustment expenses $341,902 $244,394 $212,264
Unearned premiums 16,206 13,300 11,158
Ceded reinsurance premiums payable 7,424 9,321 8,739
Convertible subordinated debentures 47,059 50,498 51,251
Accounts payable and other accrued expenses 15,969 15,265 18,788
Payable to affiliates 2,487 2,768 2,105
Deferred tax liability 3,291 2,739 1,628
---------- ---------- ----------
TOTAL LIABILITIES 434,338 338,285 305,933
-------- -------- --------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDER'S EQUITY
Common stock, no par value, 1,000 shares
authorized; shares issued and outstanding - 100 3,604 3,604 3,604
Additional paid-in capital 64,450 64,450 64,450
Accumulated other comprehensive loss:
Unrealized holding loss on available-for-sale investments (8,651) (12,200) (702)
(Accumulated deficit) retained earnings (889) 10,199 6,595
----------- ---------- ----------
TOTAL STOCKHOLDER'S EQUITY 58,514 66,053 73,947
---------- ---------- ---------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $492,852 $404,338 $379,880
======== ======== ========
See the accompanying notes to consolidated financial statements.
CII FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
Nine Months Ended Year Ended December 31,
September 30,
2000 1999 1999 1998 1997
---- ---- ---- ---- ----
(Unaudited) (Unaudited)
REVENUES
Direct written premiums, gross $153,034 $106,291 $148,824 $153,914 $135,580
Changes in direct unearned premiums (2,906) (2,579) (2,142) 127 (1,400)
---------- ---------- ---------- ----------- ----------
Direct earned premiums, gross 150,128 103,712 146,682 154,041 134,180
Less: premiums ceded 59,177 45,458 63,727 19,767 4,983
--------- --------- --------- --------- ----------
Net earned premiums 90,951 58,254 82,955 134,274 129,197
Net investment income 11,217 12,075 15,776 18,241 16,781
Net realized investment (losses) gains (460) (174) (381) 1,988 580
---------- ---------- ---------- ---------- -----------
Total revenues 101,708 70,155 98,350 154,503 146,558
------- -------- -------- -------- --------
COSTS AND EXPENSES
Loss and loss adjustment expenses 207,323 94,815 157,424 115,759 99,553
Reinsurance recoveries (123,303) (60,002) (95,963) (21,412) (6,221)
-------- -------- --------- --------- ----------
Net loss and loss adjustment expenses 84,020 34,813 61,461 94,347 93,332
Policy acquisition costs 8,606 5,737 6,339 19,216 19,860
General and administrative and other 17,372 15,000 19,749 18,761 18,462
Asset impairment 3,000
Interest expense 2,717 2,751 3,706 4,301 4,091
--------- --------- ---------- ---------- ----------
Total costs and expenses 115,715 58,301 91,255 136,625 135,745
-------- -------- --------- -------- --------
(LOSS) INCOME BEFORE FEDERAL INCOME TAX
(BENEFIT) EXPENSE AND EXTRAORDINARY GAIN (14,007) 11,854 7,095 17,878 10,813
Federal income tax (benefit) expense (4,902) 4,815 3,602 4,166 272
--------- --------- --------- ---------- -----------
(LOSS) INCOME BEFORE EXTRAORDINARY GAIN (9,105) 7,039 3,493 13,712 10,541
--------- -------- --------- --------- ---------
------------- ---------- ------------ -------------
Extraordinary gain from debt extinguishments
(net of income taxes of
$353 and $0 (unaudited), $59, $25, and $1) 654 _______ 111 48 2
---------- ---------- ------------ -------------
NET (LOSS) INCOME $ (8,451) $ 7,039 $ 3,604 $ 13,760 $ 10,543
======== ======= ======== ======== ========
See the accompanying notes to consolidated
financial statements.
CII FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(In thousands)
------------ --------- -----------
Common Stock Additional Accumulated Comprehensive (Accumulated Total
Paid-in Other Income (Loss) Deficit) Stockholder's
Number of Capital Comprehensive Retained Equity
Shares Amount Income (Loss) Earnings
------------ --------- ----------- -------------- --------------- ------------- --------------
BALANCE, JANUARY 1, 1997 100 $3,604 $58,630 $ 303 $ (17,708) $44,829
Comprehensive income:
Net income $10,543 10,543 10,543
Unrealized gain on
available-for-sale
investments, net of tax 949 949 949
Reclassification adjustment for
gains included in net income (580) (580) (580)
----------
Comprehensive income $10,912
=======
Stock option activity 1,737 1,737
------------ ------------------- ------------ ------------ --------
BALANCE, DECEMBER 31, 1997 100 3,604 60,367 672 (7,165) 57,478
Comprehensive income:
Net income 13,760 13,760 13,760
Unrealized gain on
available-for-sale
investments, net of tax 614 614 614
Reclassification adjustment for
gains included in net income (1,988) (1,988) (1,988)
---------
Comprehensive income $12,386
=======
Capital contribution from parent 3,665 3,665
Stock option activity 418 418
------------ -------------------- ------------ ------------ ---------
BALANCE, DECEMBER 31, 1998 100 3,604 64,450 (702) 6,595 73,947
Comprehensive income:
Net income 3,604 3,604 3,604
Unrealized loss on
available-for-sale
investments, net of tax (11,879) (11,879) (11,879)
Reclassification adjustment for
losses included in net income 381 381 381
---------
Comprehensive income $ (7,894)
------------ ---------------------------------- ========= ------------
BALANCE, DECEMBER 31, 1999 100 3,604 64,450 (12,200) 10,199 66,053
Comprehensive income:
Net loss (unaudited) (8,451) (8,451) (8,451)
Unrealized gain on
available-for-sale
investments, net of tax
(unaudited) 3,089 3,089 3,089
Reclassification adjustment for
losses included in net income
(unaudited) 460 460 460
---------
Comprehensive income (unaudited) $ (4,902)
=========
Dividend paid to parent (unaudited) (2,637) (2,637)
BALANCE, SEPTEMBER 30, 2000
(unaudited) 100 $3,604 $64,450 $ (8,651) $ (889) $58,514
=== ====== ======= ======== ======= =======
See the accompanying notes to consolidated financial
statements.
CII FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended Year Ended December 31,
September 30,
2000 1999 1999 1998 1997
---- ---- ---- ---- ----
(Unaudited) (Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $(8,451) $7,039 $3,604 $13,760 $10,543
Adjustments to reconcile net (loss) income to net
cash provided by operating activities:
Extraordinary gain (1,007) (170) (73) (3)
Depreciation and amortization 1,197 950 1,220 1,550 928
Provision for asset impairment 3,000
Provision for losses on premiums (144) (144)
Change in assets and liabilities:
Premiums receivable (4,011) 1,303 1,365 1,078 504
Investment income receivable 380 238 (3) 1,768 (820)
Deferred policy acquisition costs (354) (773) (574) (3) 31
Payable to affiliates (281) 3,555 662 10,213 834
Reinsurance recoverable (79,732) (39,471) (73,438) (37,011) (5,634)
Federal income taxes receivable (4,582) 2,650 (4,404) (697) (3,022)
Deferred income taxes 5,887 (1,637) (2,044)
Reserve for loss and loss adjustment expense 97,508 879 32,130 9,565 14,923
Unearned premiums 2,906 2,579 2,142 (127) 1,400
Accounts payable and other accrued expenses 704 (2,130) (3,523) 4,889 589
Ceded reinsurance premiums payable
(1,897) (3,241) 582 7,843 (42)
Other assets (7,633) 4,366 5,142 (13,988) (807)
--------- --------- --------- -------- ----------
Net cash (used in) provided by operating activities (2,253) (22,200) (29,522) (2,870) 17,380
--------- -------- -------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (820) (4,011) (4,176) (4,395) (10,419)
Purchase of available-for-sale investments (111,727) (159,576) (291,863) (682,334) (512,653)
Proceeds from sales/maturities of available-for-sale
investments 119,577 148,251 291,919 687,415 478,203
Purchase of held-to-maturity investments (1,499) (7,086) (7,133) (38,056) (7,776)
Proceeds from maturities of held-to-maturity
investments 4,366 30,980 36,077 18,087 4,872
----- ------- ------- ------- ------
Net cash provided by (used in) investing activities 9,897 8,558 24,824 (19,283) (47,773)
------ ----- ------ ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repurchase of convertible subordinated debentures
(2,432) (55) (583) (3,143) (27)
Dividend to Sierra (2,637)
Capital contribution 3,665
Stock option activity
------------
418 1,737
-------------- -- ----------------------- ---------
Net cash (used in) provided by financing activities (5,069) (55) (583) 940 1,710
---------- ------------ ----------- ---------- ---------
NET CHANGE IN CASH AND CASH EQUIVALENTS 2,575 (13,697) (5,281) (21,213) (28,683)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 16,833 22,114 22,114 43,327 72,010
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $19,408 $ 8,417 $16,833 $22,114 $43,327
======= ======== ======= ======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW DATA
Cash paid during the year for interest (net of amount $3,713 $3,712 $3,724 $4,380 $4,088
capitalized)
Cash paid during the year for income taxes 7 1,834 1,834 7,220 4,303
See the accompanying notes to consolidated
financial statements.
1. Business
CII Financial, Inc. ("CII Financial") was incorporated in the State of
California on September 15, 1988. On October 31, 1995 Sierra Health Services,
Inc. ("Sierra") acquired CII Financial for approximately $76.3 million of common
stock in a transaction accounted for as a pooling of interests. CII Financial is
a holding company primarily engaging in writing workers' compensation insurance
through its wholly-owned subsidiaries, California Indemnity Insurance Company
("California Indemnity"), Commercial Casualty Insurance Company ("Commercial
Casualty"), CII Insurance Company ("CII Insurance") and Sierra Insurance Company
of Texas ("Sierra Texas").
As used herein, the term "the Company" means CII Financial, Inc. and its
subsidiaries, and the term "CII Financial" means CII Financial, Inc., exclusive
of such subsidiaries.
2. Summary of Significant Accounting Policies
Principles of Consolidation. All significant intercompany transactions and
balances have been eliminated. The consolidated financial statements of CII
Financial include the accounts of all of its wholly-owned subsidiaries,
California Indemnity, Commercial Casualty, Sierra Texas, CII Insurance, Sierra
Insurance Agency, CII Leasing, Inc., Financial Assurance Company, Ltd. and CII
Premium Finance Company. CII Leasing, Inc. and CII Premium Finance Company are
both inactive subsidiaries.
Unaudited Financial Statements. The accompanying unaudited balance sheet,
as of September 30, 2000 and the consolidated statements of operations,
stockholder's equity and cash flows for the nine month periods ended September
30, 2000 and 1999, have been prepared in conformity with accounting principles
generally accepted in the United States of America but do not contain all of the
information and disclosures that would be required in a complete set of audited
financial statements. They should, therefore, be read in conjunction with the
audited consolidated financial statements and related notes thereto for the
years ended December 31, 1999, 1998 and 1997. In the opinion of management, the
accompanying unaudited consolidated financial statements reflect all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the financial results for the interim periods presented.
Premium Revenues. Revenue from workers' compensation premiums are
calculated by formula such that the premium written is earned pro rata over the
term of the policy. Premiums written in excess of premiums earned are recorded
as unearned premium revenue. The premium for workers' compensation insurance is
calculated as a factor of an insured's payroll dollars during the period of
coverage. At the inception of the policy, annual payroll dollars are estimated
and the policy is issued with estimated annual premiums which are billed based
on this estimate. Actual premiums for past interim coverage periods are
periodically determined through payroll reporting and interim premium audits.
The final actual premium is not determined until a final premium audit is
performed, which occurs after the policy has expired. Direct premiums earned but
not billed at the end of each accounting period are estimated and accrued,
based on historical premium audit trends. Differences between such
estimates and final billings are included in current operations. Accrued earned
but unbilled premiums are included with premiums receivable. The number and
dollar amount of issued workers' compensation insurance policies that are
subject to retrospective adjustments based on incurred or paid claims or
experienced rated premiums are not significant. Premium revenue is shown net of
premiums ceded to reinsurers.
General and Administrative Expenses. Policyholder's dividends and
management fees are included in general and administrative expenses.
Deferred Policy Acquisition Costs. Policy acquisition costs consist of
commissions, premium taxes and other underwriting costs, which are directly
related to the production and retention of new and renewal business and are
deferred and amortized as the related premiums are earned. Should it be
determined that future policy revenues and earnings on invested funds relating
to existing insurance contracts will not be adequate to cover related costs and
expenses, deferred costs are expensed.
Cash and Cash Equivalents. The Company considers cash and cash equivalents
as all highly liquid instruments with an original maturity of three months or
less at the time of purchase. The carrying amount of cash and cash equivalents
approximates fair value because of the short maturity of these instruments.
Investments. Available-for-sale debt securities and preferred stocks are
stated at fair value with unrealized gains and losses recorded as a separate
component of other comprehensive income (loss), net of deferred income taxes.
Held-to-maturity debt securities are carried at amortized cost.
The insurance subsidiaries are required by state regulatory agencies to
maintain certain deposits and must also meet certain net worth and reserve
requirements. The Company, and its subsidiaries, are in compliance with the
applicable minimum regulatory and capital requirements.
Investment income is recognized when earned. Gains and losses on
disposition are based on net proceeds and the adjusted carrying amount of the
securities sold, using the specific identification method.
The Company has an investment in a real estate limited partnership that is
accounted for under the equity method. Under the equity method, original
investments are recorded at cost and adjusted by the Company's share of
earnings, losses and distributions.
Property and Equipment. Property and equipment, consisting of buildings and
leasehold improvements, furniture and fixtures, data processing equipment and
vehicles, is stated at cost less accumulated depreciation. Depreciation is
computed on a straight-line basis over periods ranging from 5 to 10 years with
leasehold improvements depreciated over the term of the lease.
Reinsurance. In the normal course of business, insurance companies seek to
reduce the effects of events that may cause unfavorable underwriting results by
reinsuring certain levels of risk in various levels of exposure with reinsurers.
Amounts recoverable from the reinsurers are estimated in a manner consistent
with the claim liability associated with the reinsured policy. Reinsurance
receivables, including amounts related to paid and unpaid losses, are reported
as assets rather than a reduction of the related liabilities.
Reserve for Loss and Loss Adjustment Expenses. The reserve for workers'
compensation loss and loss adjustment expense ("loss and LAE") consists of
estimated costs of each unpaid claim reported to the Company prior to the close
of the accounting period as well as those incurred but not yet reported. The
methods for establishing and reviewing such liabilities are continually reviewed
and adjustments are reflected in current operations. The Company does not
discount its loss and LAE reserves.
Income Taxes. The Company accounts for income taxes using the liability
method. Deferred income tax assets and liabilities result from temporary
differences between the tax basis of assets and liabilities and the reported
amounts in the consolidated financial statements that will result in taxable or
deductible amounts in future years. The Company's temporary differences arise
principally from certain net operating losses, accrued expenses, reserves for
loss and LAE and depreciation. Federal income taxes are calculated pursuant to a
tax allocation agreement between Sierra and the Company. Income taxes are
allocated on a separate return basis for each company and tax benefits are
recorded only to the extent that an entity could recoup taxes paid in prior
years.
Concentration of Credit Risk. The Company's financial instruments that are
exposed to credit risk consist primarily of investments and accounts receivable.
The Company maintains cash and cash equivalents and investments with various
financial institutions. These financial institutions are located in many
different regions, and Company policy is designed to limit exposure with any one
institution.
Credit risk with respect to accounts receivable is generally diversified
due to the large number of entities comprising the Company's customer base and
their dispersion across many different industries. These customers are primarily
located in the states in which the Company operates principally California,
Colorado, Nevada and Texas. However, the Company is licensed and does business
in several other states. The Company also has receivables from certain
reinsurers. Reinsurance contracts do not relieve the Company from its
obligations to policyholders. Failure of reinsurers to honor their obligations
could result in losses to the Company. The Company evaluates the financial
condition of its reinsurers to minimize its exposure to significant losses from
reinsurer insolvencies. All reinsurers that the Company has reinsurance
contracts with are rated A- or better by the A.M. Best Company.
Recently Issued Accounting Standards. In June 1998, the Financial
Accounting Standards Board (the "FASB") issued Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"), as amended, which is effective for fiscal years
beginning after June 15, 2000. SFAS 133 establishes additional accounting and
reporting standards for derivative instruments and hedging activities. SFAS 133
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position. This statement also defines
and allows companies to apply hedge accounting to its designated derivatives
under certain instances. It also requires that all derivatives be marked to
market on an ongoing basis. This applies whether the derivatives are stand-alone
instruments, such as warrants or interest rate swaps, or embedded derivatives,
such as call options contained in convertible debt investments. Along with the
derivatives, in the case of qualifying hedges, the underlying hedged items are
also to be marked to market. These market value adjustments are to be included
either in the income statement or other comprehensive income, depending on the
nature of the hedged transaction. The fair value of financial instruments is
generally determined by reference to market values resulting from trading on a
national securities exchange or in an over the counter market. In cases where
derivatives relate to financial instruments of non-public companies, or where
quoted market prices are otherwise not available, such as for derivative
financial instruments, fair value is based on estimates using
present value or other valuation techniques. Based on management's
understanding of SFAS 133, the Company does not believe that it has any
derivative instruments and does not have any hedging activities. The majority of
the Company's investments are held by insurance companies, which are regulated
as to the types of investments they may hold.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"). SAB 101 clarifies existing accounting principles related to revenue
recognition in financial statements. The Company is required to comply with the
provisions of SAB 101 in its quarter ending December 31, 2000. Based upon the
current nature of the Company's operations, management does not believe that SAB
101 will have any impact on the Company's results of operations.
Business Segment. As of December 31, 1999 the Company operated in a single
business segment, workers' compensation insurance.
Use of Estimates in the Preparation of Financial Statements. The
preparation of the Company's financial statements requires management to make
estimates and assumptions that affect the amounts of reported assets and
liabilities, particularly loss and LAE reserves and incurred loss and LAE
reported in the financial statements. Loss and LAE reserves have a significant
degree of uncertainty when related to their subsequent payments. Although
reserves are established on the basis of a reasonable estimate, it is not only
possible but probable that reserves will differ from their related subsequent
developments. Underlying causes for this uncertainty include, but are not
limited to, uncertainty in development patterns and unanticipated inflationary
trends affecting the services provided by the insurance contract. This
uncertainty can result in both adverse as well as favorable development of
actual subsequent activity when compared to the reserve established. Any
subsequent change in loss and LAE reserves established in a prior year would be
reflected in the current year's operating results.
3. Property and Equipment
Property and equipment at December 31, consists of the following (in
thousands):
1999 1998
-------- -- ----
Buildings and leasehold improvements $1,124 $ 974
Furniture, fixtures and equipment 3,003 2,936
Data processing equipment and software 3,560 3,154
Construction in progress 5,178 1,625
Less: accumulated depreciation (4,511) (3,436)
------ ------
Net property and equipment $8,354 $5,253
======= ======
Depreciation expense in 1999, 1998 and 1997 was $1,075,000, $1,345,000 and
$722,000, respectively.
During the second quarter of 2000 the Company wrote-off capitalized costs
of $3.0 million related to the application development of an information system
software project that was canceled because the vendor was unable to fulfill its
contractual
obligations. The amounts written off include software and consulting costs
of $1,687,000 and capitalized internal personnel costs of
$1,314,000.
4. Investments
The following table summarizes the Company's debt securities and preferred
stock investments as of December 31, 1999 (in thousands):
-----------
Gross Gross
----------- Unrealized Unrealized Fair Value
Amortized Gains Losses
Cost
Available-for-Sale:
U.S. Government
and its Agencies.......................................... $101,102 $122 $13,041 $ 88,183
Municipal Obligations......................................... 31,818 20 1,236 30,602
Corporate Bonds............................................... 32,907 45 1,730 31,222
Other......................................................... 17,908 2,619 15,289
Total Debt Securities......................................... 183,735 187 18,626 165,296
Preferred Stock............................................... 3,817 331 3,486
Total Available-for-Sale................................... $187,552 $187 $18,957 $168,782
Held-to-Maturity
U.S. Government
========================================================================
and its Agencies.......................................... $9,782 $341 $ 708 $ 9,415
Municipal Obligations......................................... 5,558 64 55 5,567
Corporate Bonds............................................... 5,738 115 5,853
Other......................................................... 3,945 751 3,194
Total Held-to-Maturity...................................... $25,023 $520 $1,514 $ 24,029
The following table summarizes the Company's debt securities and preferred stock
investments as of December 31, 1998 (in thousands):
-----------
Gross Gross
----------- Unrealized Unrealized Fair Value
Amortized Gains Losses
Cost
Available-for-Sale:
U.S. Government $
and its Agencies.......................................... $78,071 $717 $1,189 77,599
Municipal Obligations......................................... 23,585 145 227 23,503
Corporate Bonds............................................... 76,479 596 823 76,252
Other......................................................... 8,542 19 271 8,290
Total Debt Securities......................................... 186,677 1,477 2,510 185,644
Preferred Stock............................................... 931 9 58 882
Total Available-for-Sale.................................... $187,608 $1,486 $2,568 $186,526
Held-to-Maturity
U.S. Government
========================================================================
and its Agencies.......................................... $15,492 $ 47 $ 483 $ 15,056
Municipal Obligations......................................... 6,300 319 6,619
Corporate Bonds............................................... 11,909 557 12,466
Other......................................................... 20,266 937 19,329
Total Held-to-Maturity...................................... $53,967 $ 923 $1,420 $ 53,470
===============================================================================
The contractual maturities of available-for-sale debt securities at December 31,
1999 are shown below. Actual maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations.
(in thousands) Amortized Estimated
Cost Fair Value
Due in one year or less....................................... $ 8,492 $ 8,485
Due after one year through five years......................... 38,414 37,688
Due after five years through ten years........................ 13,909 13,298
Due after ten years through fifteen years..................... 13,844 12,664
Due after fifteen years....................................... 109,076 93,161
--------- ---------
Total.................................................... $183,735 $165,296
======== ========
- -------------------------------------------------------------------------------
The contractual maturities of held-to-maturity debt securities at December 31,
1999 are shown below. Actual maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations:
(in thousands) Amortized Estimated
Cost Fair Value
Due in one year or less....................................... $ 2,580 $ 2,611
Due after one year through five years......................... 9,565 9,585
Due after five years through ten years........................ 776 775
Due after ten years through fifteen years..................... 4,795 4,565
Due after fifteen years....................................... 7,307 6,493
--------- -----------
Total.................................................... $25,023 $ 24,029
======= ========
- -------------------------------------------------------------------------------
Gross realized gains on investments for the nine months ended September 30,
2000 and the years ended December 31, 1999, 1998 and 1997 were $220,000
(unaudited), $261,000, $4,120,000 and $2,517,000, respectively. Gross realized
losses on investments for the nine months ended September 30, 2000 and the years
ended December 31, 1999, 1998 and 1997 were $680,000 (unaudited), $642,000,
$2,132,000 and $1,937,000, respectively.
Investment income, by major category of investments, is summarized as
follows (in thousands):
Nine months ended
September 30, Year Ended December 31,
2000 1999 1999 1998 1997
-------- -- ----- -- ----- -------- ------
(Unaudited) (Unaudited)
Interest from debt securities $10,352 $10,962 $14,387 $17,175 $16,206
Dividend income from preferred stock 280 328 411 511 358
Mortgage interest 592 928 1,130 734 397
Other 42 ______
----------- -------- --------------
Total investment income 11,266 12,218 15,928 18,420 16,961
Investment expenses 49 143 152 179 180
----------- --------- ---------- ---------- ----------
Net investment income $11,217 $12,075 $15,776 $18,241 $16,781
======= ======= ======= ======= =======
Of the total debt securities and cash equivalents, $152,356,000,
$171,639,000 and $179,878,000, at fair value, were on deposit with regulatory
authorities in compliance with certain legal requirements related to the
insurance operations at September 30, 2000, December 31, 1999 and 1998,
respectively.
The Company holds certain mortgage notes on residential and commercial real
estate. In connection with CII Financial's relocation of its principal executive
offices to Pleasanton, California in July 1992, to retain key officers and other
employees, the Company extended mortgage loans for the purchase of such
employees' principal residences. The
interest rate was reduced to a fixed rate of 3% per annum; the maturity date was
fixed to March 2009; and each loan can be assumed, one time, by a qualified
purchaser of the employee's residence. The interest rate, upon assumption,
increases to 3.5% per annum. As of December 31, 1999 and 1998, the outstanding
balances on employee relocation loans were $4,764,000 and $4,949,000,
respectively. The Company also holds commercial mortgage loans, the majority of
which are with Sierra affiliates. These loans are also first trust deeds and
earn between 7% and 11 1/2% per annum. The Company has one mortgage loan with a
non-affiliated third party which is currently in default; the principle balance
outstanding was $1,633,000 at September 30, 2000. The property has been
appraised at a value that exceeds book value. Interest income has not been
accrued since the default date. The Company is currently litigating the priority
of its lien on the property. The Company has made demand under its title
insurance policy and will foreclose pending the outcome of the litigation on its
claim.
5. Reinsurance
The Company has reinsurance agreements or treaties in effect with unrelated
entities. In 1999 and 1998, workers' compensation claims between $500,000 and
$100,000,000 per occurrence are 100% reinsured. In 1997, workers' compensation
claims between $350,000 and $60,000,000 per occurrence were 100% reinsured. In
addition, effective July 1, 1998, workers' compensation claims below $500,000
per occurrence were reinsured under quota share and excess of loss reinsurance
agreements (referred to as "low level reinsurance") with an A+ rated carrier.
Under this agreement, the Company reinsures 30% of the first $10,000 of each
loss, 75% of the next $40,000 and 100% of the next $450,000. The Company
receives a 9.25% ceding commission from the reinsurer as a partial reimbursement
of its operating expenses. The low level reinsurance agreement expired on June
30, 2000; however the Company opted to continue ceding premiums and losses under
the low level agreement on a run off basis for all policies in force on June 30,
2000. Effective January 1, 2000 we entered into a reinsurance contract that
provides statutory (unlimited) coverage for workers' compensation claims in
excess of $500,000 per occurrence. The contract is in effect for claims
occurring on or after January 1, 2000 through December 31, 2000. On July 1,
2000, the Company entered into a reinsurance agreement that covers losses on
claims in excess of $250,000 to $500,000 for policies issued after June 30,
2000.
The low level reinsurance agreement was consummated early in the fourth
quarter of 1998 but coverage was made retroactive to July 1, 1998. Therefore,
this agreement contained both retroactive (covering claims occurring in the
third calendar quarter of 1998) and prospective reinsurance coverage (covering
claims occurring after September 30, 1998) and, in accordance with Statement of
Financial Accounting Standards No. 113, "Accounting and Reporting for
Reinsurance of Short-Duration and Long-Duration Contracts" ("SFAS 113"), the
Company has bifurcated the low level reinsurance agreement to account for the
different accounting treatments. The amount by which the estimated ceded
liabilities exceed the amount paid for the retroactive coverage is reported as a
deferred gain and amortized to income as a reduction of incurred losses over the
estimated remaining settlement period using the interest method. Any subsequent
changes in estimated or actual cash flows related to the retroactive coverage
are accounted for by adjusting the previously recorded deferred gain to the
balance that would have existed had the revised estimate been available at the
inception of the reinsurance transactions, with a corresponding charge or credit
to income. During 1999, the Company recorded an adjustment to increase its
deferred gain related to retroactive reinsurance coverage by $4,615,000. For the
years ended December 31, 1999 and 1998, the Company amortized deferred gains of
$3,850,000 and $1,038,000, respectively.
In accordance with SFAS 113, losses ceded under prospective reinsurance
reduce direct incurred losses and amounts recoverable are reported as an asset.
At December 31, 1999 and 1998, the amount of reinsurance recoverable under
prospective reinsurance contracts for unpaid loss and LAE was $110,089,000 and
$37,797,000, respectively. At December 31, 1999 and 1998, the amount of
reinsurance recoverable under the retroactive reinsurance contract was
$14,842,000 and $18,710,000, respectively. The amount of reinsurance receivable
for paid loss and LAE was $6,931,000 and $1,917,000 at December 31, 1999 and
1998, respectively. Such amortization is included in loss and loss adjustment
expense on the accompanying consolidated statements of operations.
Reinsurance contracts do not relieve the Company from its obligations to
enrollees or policyholders. Failure of reinsurers to honor their obligations
could result in losses to the Company. The Company evaluates the financial
condition of its reinsurers to minimize its exposure to significant losses from
reinsurer insolvencies. Substantially all of the reinsurance recoverables are
due from reinsurers rated A+ by the A.M. Best Company and all amounts are
considered to be collectible.
The following table provides workers' compensation prospective reinsurance
information for the periods ended (in thousands):
Change in
Recoveries Recoverable
on Paid or Unpaid Premiums
Loss / LAE Loss / LAE Ceded
Nine Months Ended September 30, 2000 (Unaudited):
Low level reinsurance carrier $36,180 $79,170 $56,732
Excess of loss reinsurance carriers 1,678 6,275 2,445
--------- --------- ---------
Total $37,858 $85,445 $59,177
======= ======= =======
Nine Months Ended September 30, 1999 (Unaudited):
Low level reinsurance carrier $14,088 $40,191 $43,264
Excess of loss reinsurance carriers 2,578 3,145 2,194
--------- --------- ---------
Total $16,666 $43,336 $45,458
======= ======= =======
Year Ended December 31, 1999:
Low level reinsurance carrier $21,941 $69,104 $60,702
Excess of loss reinsurance carriers 1,730 3,188 3,025
--------- --------- ---------
Total $23,671 $72,292 $63,727
======= ======= =======
Year Ended December 31, 1998:
Low level reinsurance carrier $ 1,379 $19,664 $16,095
Excess of loss reinsurance carriers 3,292 (2,923) 3,672
-------- -------- ---------
Total $ 4,671 $16,741 $19,767
======= ======= =======
Year Ended December 31, 1997:
Excess of loss reinsurance carriers $ 841 $ 5,380 $ 4,983
======== ======== ========
6. Loss and Loss Adjustment Expenses
The following table provides a reconciliation of the beginning and ending
reserve balances for unpaid loss and LAE. The loss estimates are subject to
change in subsequent accounting periods and any change to the current reserve
estimates would be accounted for in future results of operations.
While management of the Company believes that current estimates are
reasonable, significant adverse or favorable loss development could occur in the
future.
Nine Months Ended
(In thousands) September 30, Year Ended December 31,
2000 1999 1999 1998
---- -------- ---- ------- ------------ ---- -------
(Unaudited) (Unaudited) 1997
Net beginning loss and LAE reserve $134,305 $174,467 $174,467 $181,643 $172,100
-------- -------- -------- -------- --------
Net provision for insured events incurred in:
Current year 63,843 36,061 51,541 103,990 102,302
Prior years 20,177 (1,248) 9,920 (9,643) (8,970)
--------- --------- ---------- ----------- ---------
Total net provision 84,020 34,813 61,461 94,347 93,332
--------- --------- --------- ---------- ---------
Net payments for loss and LAE Attributable to insured events incurred in:
Current year 15,763 12,836 21,207 29,591 26,812
Prior years 49,893 64,668 80,416 71,932 56,977
--------- -------- --------- --------- ---------
Total net payments 65,656 77,504 101,623 101,523 83,789
--------- -------- -------- -------- ---------
Net ending loss and LAE reserve 152,669 131,776 134,305 174,467 181,643
Reinsurance recoverable 189,233 81,367 110,089 37,797 21,056
--------- --------- -------- --------- ----------
Gross ending loss and LAE reserve $341,902 $213,143 $244,394 $212,264 $202,699
======== ======== ======== ======== ========
During the nine months ended September 30, 2000, the Company experienced
net adverse development related to accident years 1999 and prior. Estimated loss
and LAE incurred in accident years 1996 to 1998 have developed significantly in
response to the continuation of increasing claim severity patterns on the
Company's California book of business. Many workers' compensation insurance
carriers in California are also experiencing high claim severity. For claims
occurring on and after July 1, 1998, the Company has reinsured a percentage of
the higher claim severity to its reinsurer under the Company's low level
reinsurance agreement. The low level reinsurance agreement expired on June 30,
2000; however the Company opted to continue ceding premiums and losses under the
low level agreement on a run off basis for all policies in force on June 30,
2000. Effective January 1, 2000 we entered into a reinsurance contract that
provides statutory (unlimited) coverage for workers' compensation claims in
excess of $500,000 per occurrence. The contract is in effect for claims
occurring on or after January 1, 2000 through December 31, 2000. On July 1,
2000, the Company entered into a reinsurance agreement that covers losses on
claims in excess of $250,000 to $500,000 for policies issued after June 30,
2000.
7. Long Term Debt
7 1/2% Convertible Subordinated Debentures. The Company's long-term debt at
September 30, 2000 and December 31, 1999 and 1998 consists of convertible
subordinated debentures with an outstanding balance of $47,059,000, $50,498,000
and $51,251,000 respectively. In September 1991, the Company issued convertible
subordinated debentures (the "Debentures") due September 15, 2001. The
Debentures bear interest at 7 1/2% which is due semi-annually on March 15 and
September 15. Each $1,000 in principal is convertible into 25.382 shares of
Sierra common stock at a conversion price of $39.398 per share. Unamortized
issuance costs of $111,000, $362,000 and $509,000 at September 30, 2000 and
December 31, 1999 and 1998, are included in other assets on the consolidated
balance sheets and are being amortized over the life of the Debentures. Accrued
interest on the Debentures as of September 30, 2000 and December 31, 1999 and
1998 was $111,000, $1,099,000 and $1,117,000, respectively. The Debentures are
redeemable in whole or in part, at a redemption price of 100.75% plus accrued
interest. The Debentures are subordinated obligations of CII Financial only and
were not assumed or guaranteed by Sierra. During the nine months ended September
30, 2000 and the years ended December 31, 1999, 1998 and 1997, the Company
and/or Sierra repurchased $3,457,000, $753,000, $3,216,000 and $30,000
respectively, of the debentures on the open market resulting in extraordinary
gains of $1,007,000, $170,000, $73,000 and $3,000 and a corresponding tax
provision of $353,000, $59,000, $25,000 and $1,000 in 2000, 1999, 1998 and 1997
respectively.
Sale and purchase activity for the Debentures, to parties other than the
Company or Sierra, is believed to be minimal and there is no known market
quotation system for the Debentures. The fair value of the Debentures at
September 30, 2000 and December 31, 1999 was $23,530,000 and $35,601,000,
respectively, which was determined based on purchases made by the Company during
September 2000 and the estimated market price on December 31, 1999. The
September 30, 2000 price is based on $18,000 stated value debentures purchased
for $9,000 and may not be indicative of the actual market value. The Debentures
are scheduled to mature on September 15, 2001.
CII Financial has limited sources of cash and borrowed approximately
$365,000 from Sierra to make the September 15, 2000 interest payment. CII
Financial is dependent upon dividends from its subsidiary, California Indemnity
Insurance Company, to meet its debt payment obligations. Currently, California
Indemnity cannot pay any dividends without prior approval by the California
Department of Insurance as it has no earned surplus and it may not have
sufficient earned surplus from which to pay a dividend to CII Financial when the
Debentures mature in 2001. Sierra has no obligation to lend any or enough funds
to CII Financial to pay the Debentures when they mature. Accordingly, CII
Financial does not expect to have readily available funds to pay the Debentures
when they mature. The Company is exploring strategies regarding refinancing of
the 7 1/2% subordinated convertible debentures including refinancing, extending
the maturity date or exchanging the Debentures. There can be no assurances that
CII Financial or Sierra will have the cash resources required to meet the
obligations under the Debentures or that the Company will be able to
successfully implement a strategy for refinancing of the Debentures. In December
2000, CII Financial commenced a proposed exchange offer to the holders of the 7
1/2% debentures to restructure the debt, extend the maturity date and reduce the
overall debt of the Company. The offering proposed to exchange an amount of cash
plus new subordinated debentures with a later maturity date.
8. Commitments and Contingencies
Leases. The Company is the lessee under several operating leases most of
which relate to office facilities and equipment. The rentals on these leases are
charged to expense over the lease term and, where applicable, provide for rent
escalations based on certain costs and price index factors. The following is a
schedule, by year, of the future minimum lease payments under existing operating
leases (in thousands):
Year Ending December 31,
2000............................................. $ 2,756
2001............................................. 2,617
2002............................................. 2,457
2003............................................. 1,661
2004............................................. 1,297
Thereafter....................................... 5,342
----------
Total....................................... $ 16,130
========
Rent expense totaled $2,602,000, $1,314,000 and $1,313,000 in 1999, 1998
and 1997, respectively.
Guaranty of Sierra's Credit Facility Debt. At June 30, 2000, Sierra was not
in compliance with certain financial covenants relating to its line of credit.
The lenders provided Sierra with waivers effective June 30, 2000 and expiring
October 31, 2000. In consideration for the banks granting one of the waivers, in
August 2000, CII Financial became a guarantor of the Sierra credit facility
debt. Should CII Financial be asked by the banks to perform on its guaranty, the
Debentures would be subordinated to Sierra's credit facility debt. The waivers
expired on October 31, 2000 and Sierra received a Notice of Default from the
banks on November 8, 2000. No demand was made by the banks to perform on the
guaranty and Sierra was able to amend its credit facility agreement on December
15, 2000. The new Sierra credit facility agreement expires on September 30,
2003. In the amended agreement, CII Financial continues to provide a guaranty of
the debt in the event of a default by Sierra.
Litigation and Legal Matters. The Company is subject to various claims and
other litigation in the ordinary course of business. Such litigation includes
claims for workers' compensation and claims by providers for payment for medical
services rendered to injured workers. In the opinion of the Company's
management, the ultimate resolution of pending legal proceedings should not have
a material adverse effect on the Company's financial condition.
9. Federal Income Taxes
A summary of the provision for income taxes for the years ended December
31, 1999, 1998 and 1997 is as follows (in thousands):
Year Ended December 31,
1999 1998 1997
-------- -------- ------
(Benefit) provision for income taxes:
Current tax on operating income ($2,286) $6,829 $3,045
Deferred tax on operating income 5,888 (2,663) (2,773)
------- ------ -----
Total tax on operating income 3,602 4,166 272
Current tax on extraordinary gain 59 25 1
---------- --------- ----------
Total $3,661 $4,191 $ 273
======= ====== ======
The following reconciles the difference between the 1999, 1998 and 1997
reported and statutory provision for income taxes:
1999 1998 1997
-- ------ -- ------ -- ----
Statutory rate 35% 35% 35%
Tax preferred investments (6%) (2%) (4%)
Change in valuation allowance 16% (11%) (34%)
Other 5% 1% 5%
------- ------ -----
Provision for income taxes 50% 23% 2%
====== ===== =====
In 1991 and 1992, California Indemnity had taxable net operating losses
("NOLs") that were available, under the tax sharing agreement, to be carried
forward to offset future taxable income. The deferred income tax asset related
to these NOLs was fully reserved with a valuation allowance. In 1997 and 1998,
California Indemnity had taxable operating income, which was partially offset by
the NOLs, due to the separate return limitation year rules. The valuation
allowances were reversed as the NOL was used and the NOLs were fully utilized in
1998.
On a separate return basis, CII Financial has historically had taxable
NOLs, including the three years ended December 31, 1999. Under the tax sharing
agreement, valuation allowances have been established for the deferred income
tax asset related to CII Financial's NOLs as they can only utilize the NOLs to
the extent that they have income on a separate return basis.
Under the tax sharing agreement,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the amount and expiration dates of CII Financial's NOLs as of December 31, 1999
are as follows:
Generated Amount Expires
--------- ------ -------
1993 $ 1,935,000 2008
1994 7,185,000 2009
1995 6,533,000 2009
1995 793,000 2010
1996 3,339,000 2011
1997 4,122,000 2012
1998 3,685,000 2018
1999 3,250,000 2019
------------------
$30,842,000
==================
F-26
The tax effects of significant items comprising the Company's net deferred
tax assets are as follows (in thousands):
1999 1998
-- ------ -- ----
Deferred tax assets:
Loss and LAE reserves $ 1,956 $ 6,401
Accruals not currently deductible 1,128 1,374
Compensation accruals 616 754
Bad debt allowances 397 447
Loss carryforwards and credits 13,514 12,657
Unearned premiums 935 781
Deferred reinsurance gains 2,456 2,188
Unrealized investment losses 6,569 378
--------- ---------
Total 27,571 24,980
Deferred tax liabilities:
Deferred policy acquisition costs 832 631
Depreciation and amortization 1,255 454
Other 652 543
---------- ----------
Total 2,739 1,628
Net deferred tax asset before valuation allowance 24,832 23,352
Valuation allowance (10,227) (9,052)
------- ---------
Net deferred tax asset $14,605 $14,300
======= =======
In lieu of state franchise and corporate income taxes, California
Indemnity, Commercial Casualty, CII Insurance and Sierra Texas pay premium taxes
based upon direct written premiums to the states in which they write business.
Premium tax expense of $4,078,000, $4,228,000 and $3,730,000 is included in
policy acquisition costs in the consolidated statements of operations for the
years ended December 31, 1999, 1998 and 1997, respectively.
Current tax receivable balances are $6,919,000, $4,896,000 and $492,000 as
of September 30, 2000 and December 31, 1999 and 1998, respectively. These
amounts are due from Sierra as the administrative agent under the tax sharing
agreement.
10. Dividend Restrictions - Insurance Subsidiaries
Under California insurance company statutes and regulations, California
Indemnity, Commercial Casualty and CII Insurance are restricted as to the amount
of dividends they may pay on their common stock to their respective parent
companies. Sierra Texas is regulated by Texas insurance statutes and regulations
that are similar to California in terms of paying dividends. No dividends may be
paid without at least ten business days prior notice to the Insurance
Commissioner. Unless specially approved by the Insurance Commissioner prior to
payment, dividends may be paid only out of accumulated earned surplus, excluding
any earned surplus attributable to unrealized appreciation in assets or an
exchange of assets.
If a dividend or other distribution is contemplated which, along with all
other dividends or distributions made within the preceding twelve months,
exceeds the greater of 10% of the insurance company's policyholders' surplus as
of the end of the prior calendar year or net income for such calendar year, at
least 30 days prior notice to the Commissioner must be given, and no payment of
the dividend or distribution may be made unless and until (i) the Commissioner
has approved it or (ii) the 30 days have elapsed and the Commissioner has not
disapproved the proposed payment.
Net income and stockholder's equity of domestic insurance subsidiaries, as
filed with regulatory authorities on the basis of statutory accounting
practices, are summarized as follows (in thousands):
Nine Months Year Ended December 31,
Ended
September 30,
2000 1999 1998 1997
--------- --------- --------- -------
(Unaudited)
Statutory net (loss) income for the period ended $ (7,185) $ 12,283 $ 20,877 $11,277
Statutory stockholder's equity at the
period ended 106,078 118,278 116,580 96,061
Based on its financial position as of December 31, 1999, California
Indemnity can pay $6,840,000 in shareholder dividends to CII Financial during
2000 without the prior approval of the California Insurance Commissioner.
Commercial Casualty, CII Insurance and Sierra Texas can pay $1,686,000, $376,000
and $216,000, respectively to California Indemnity without prior approval of the
applicable state insurance commissioner.
CII Financial, Inc. paid dividends of $2,637,000, in March 2000, to
Sierra. California Indemnity paid dividends to CII Financial of $6,800,000 and
$6,000,000, during 2000 and 1999, respectively. During 1999, Commercial Casualty
paid $1,700,000 in dividends to California Indemnity. Due notice was filed with
the California Department of Insurance, and the payment was made after the
expiration of the required waiting period in accordance with California
Insurance regulations.
The National Association of Insurance Commissioners adopted risk-based
capital guidelines for property-casualty insurance companies whereby required
statutory surplus would be based, in part, on a formula based risk assessment of
the individual investments held in the insurance company's portfolio. The
Company's risk-based capital results for the years ended December 31, 1999, 1998
and 1997 exceeded the minimum surplus required under the regulations.
In March 1998, the NAIC adopted the Codification of Statutory Accounting
Principals (the "Codification"). The Codification, which is intended to
standardize regulatory accounting and reporting for the insurance industry,
becomes effective January 1, 2001. However, statutory accounting principles will
continue to be established by individual state laws and permitted practices. The
state of California has indicated that it intends to require adoption of the
Codification for the preparation of statutory financial statements. The Company
has not finalized the quantification of the effects of the Codification on its
statutory financial statements.
11. Employee Compensation and Benefit Plans
Defined Contribution Plan. All employees who meet minimum requirements can
participate in Sierra's defined contribution pension and 401(k) plan (the
"Plan"). The Plan covers all employees who meet certain age and length of
service requirements. For the years ended December 31, 1998 and 1997 and for the
six months ended June 30, 1999, the Company contributed a maximum of 2% of
eligible employees' compensation and matched 50% of a participant's elective
deferral up to a maximum of either 10% of an employee's compensation or the
maximum allowable under current IRS statute. Effective July 1, 1999, the Plan
was modified such that the Company matches 50%-100% of an employee's elective
deferral and the maximum Company match is 6% of a participant's annual
compensation, subject to Internal Revenue Service limits. The Plan does not
require additional Company contributions. For the years ended December 31, 1999,
1998 and 1997, the Company expensed $601,000, $625,000 and $630,000,
respectively, to this plan.
Executive Retirement Plans. The Company offered key employees and officers
a Supplemental Executive Retirement Plan and Supplemental Senior Executive
Retirement Plan. Eligibility for participation in both plans was limited to
officers and key employees selected and approved by the Board of Directors.
These plans were terminated effective October 31, 1995, and there have been no
further contributions. Pursuant to contractual obligations under the plans, the
Company paid $250,000 to a former plan participant in each of the years ended
December 31, 1999, 1998 and 1997.
Employment Contracts. The Company currently has an employment contract
with its Chief Executive Officer expiring December 2001. Minimum aggregate cash
compensation obligations under this contract are $214,000 for both 2000 and
2001.
Employee Stock Purchase Plan. The Company offers employee stock purchase
plans through Sierra (the "Purchase Plan") whereby employees may purchase newly
issued shares of stock through payroll deductions at 85% of the fair market
value of such shares on specified dates as defined in the Purchase Plan.
Stock Option Plans. The Company offers several plans, through Sierra, that
provide common stock-based awards to employees and to non-employee directors.
The plans provide for the granting of options, stock, and other stock-based
awards. Awards are granted by a committee appointed by the Sierra Board of
Directors and no specific amount has been reserved for the Company's employees.
Options become exercisable at such times and in such installments as set by the
committee. The exercise price of each option equals the market price of Sierra
stock on the date of grant. Stock options generally vest at a rate of 20% - 25%
per year. Options generally expire one year after the end of the vesting period.
The tax benefit related to the exercise of options by Company employees is
passed on to the Company by Sierra. This totaled $0, $418,000 and $1,737,000 for
1999, 1998 and 1997 respectively.
The following table reflects the activity of the stock option plans:
Number of Option Weighted
Shares Price Average Price
Outstanding January 1, 1997 838,000 $ 6.31 - $23.33 $12.78
Granted.................................. 59,000 17.58 - 24.50 22.87
Exercised................................ (481,000) 6.31 - 21.17 11.86
Canceled................................. (3,000) 6.31 - 16.67 12.89
----------
Outstanding December 31, 1997 .............. 413,000 6.31 - 24.50 15.31
Granted.................................. 32,000 16.94 - 22.38 21.53
Exercised................................ (110,000) 6.31 - 19.08 13.21
Canceled................................. (12,000) 9.91 - 24.50 17.85
-------------
Outstanding December 31, 1998............... 323,000 6.31 - 24.50 16.56
Granted.................................. 152,000 6.69 - 21.00 8.87
Exercised................................ (1,000) 6.31 - 11.71 7.81
Canceled................................. (19,000) 11.71 - 24.50 13.87
---------
Outstanding December 31, 1999............... 455,000 6.31 - 24.50 14.12
========
Exercisable at December 31, 1999 ........... 203,000 $ 6.31 - $24.50 $16.23
=======
The following table summarizes information about stock options outstanding at
December 31, 1999:
Weighted Average Weighted Average
Range of Exercise Contractual Life Options Exercise Price
Prices Remaining in Days Outstanding Exercisable Outstanding Exercisable
- ----------------------- ----------------- ---------------------------- ----------------------------
$ 6.31 - $ 8.00 1,981 152,000 16,000 $ 7.24 $ 4.82
9.91 - 12.08 4,445 88,000 53,000 10.65 10.52
16.67 - 21.17 1,039 137,000 102,000 17.19 17.11
22.38 - 24.50 1,513 78,000 32,000 21.34 18.29
Accounting for Stock-Based Compensation. The Company uses the intrinsic
value method in accounting for its stock-based compensation plans. Accordingly,
no compensation cost has been recognized for its employee stock option plans nor
the Purchase Plans. Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value at the grant dates
for awards under those plans, the Company's net income for the years ended
December 31 would have been reduced to the pro forma amounts indicated below:
For the Years Ended
-----------------------------------------------------
1999 1998 1997
---- ---- ----
Net Income As reported $3,604,000 $13,760,000 $10,543,000
Pro forma 3,188,000 13,479,000 10,291,000
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1999, 1998 and 1997, respectively: dividend yield
of 0% for all years; expected volatility of 43%, 37% and 35%; risk-free interest
rates of 5.86%, 4.43% and 5.91%; and expected lives of four to five years. The
weighted average fair value of options granted in 1999, 1998 and 1997 was $3.82,
$9.34 and $12.43, respectively.
The fair value of the look-back option implicit in each offering of the
Purchase Plans is estimated on the date of grant using the Black-Scholes option
pricing model with the following weighted average assumptions used for grants in
1999, 1998 and 1997, respectively: dividend yield of 0% for all years; expected
volatility of 45%, 32% and 35%; risk-free interest rates of 4.66%, 5.30%, and
5.32%; and expected lives of six months for all years.
During 1999, the Company extended by three years the expiration date
for 6,000 options covering shares that would have expired in 1999 and 2000. The
exercise price per share for these options ranges from $12.08 to $19.08. No
expense was recognized in the consolidated statement of operations related to
these options. Expense of $31,000 is included in the Pro forma information
presented.
Due to the fact that the Company's stock option programs vest over many
years and additional awards are made each year, the above pro forma numbers are
not indicative of the financial impact had the disclosure provisions of FAS 123
been applicable to all years of previous option grants. The above numbers do not
include the effect of options granted prior to 1995.
F-25
12. Other Related Party Transactions
The Company entered into a management services agreement with Sierra
effective January 1, 1999. The agreement provides investment, accounting, human
resources, systems and other administrative services. The fee for the services
is based on actual direct and allocable costs related to the services rendered
and does not include any management overhead allocations. Allocable costs,
consisting primarily of rent and related property expenses, equipment and other
non-labor costs, were pro ratably determined using methods that management
believes are reasonable and appropriate. The methods of allocations were
primarily determined based on the number of employees and occupied square
footage. Management fee expense for 1999 totaled $1,338,000. The Company did not
have a management agreement with Sierra prior to January 1, 1999.
The Company purchases employee health insurance from its affiliates,
Health Plan of Nevada, Inc., Sierra Health and Life Insurance Company, Inc. and
Texas Health Choice, L.C. The Company paid $642,000, $528,000 and $498,000 to
the aforementioned affiliates for years ended 1999, 1998 and 1997, respectively.
The premiums paid to its affiliates were determined on an arms-length basis.
At January 1, 1998, California Indemnity had an investment in real estate
owned and occupied of $11,959,000. During the year, California Indemnity
obtained a mortgage loan on this property in the amount of $5,000,000. In the
fourth quarter of 1998, the property, net of the mortgage loan, with a book
value of $8,442,000, which approximated fair value, was contributed to a real
estate limited partnership of which Sierra is the general partner. California
Indemnity agreed to adjust its partnership interest to approximate its
occupancy. The adjustment, which was based on the then equity value of the
partnership, resulted in Sierra purchasing a portion of California Indemnity's
interests for $2,262,000. Simultaneously with the execution of the partnership
agreement, California Indemnity contributed one-half of its adjusted interest
into the limited partnership, valued at $3,092,000, to its wholly-owned
subsidiary, Commercial Casualty. There were no gains or losses recorded on these
transactions as book value approximated fair value at the time of the
transaction. Together, California Indemnity and Commercial Casualty own limited
partner interests totaling approximately 27% of the limited partnership. These
transactions were done to enable both companies to qualify for certain premium
tax credits in the state of Nevada and were approved by the California
Department of Insurance. As part of the transaction to form and fund the limited
partnership, California Indemnity was released from any obligation directly
under the mortgage loan.
Concurrent with the sale of the real estate, California Indemnity entered
into a rental agreement with the related partnership under which California
Indemnity leases a portion of the transferred real estate. Rental expense under
this agreement was approximately $1,168,000 and $270,000 in 1999 and 1998,
respectively. In December 2000, in conjunction with a sale-leaseback
transaction of Sierra's Las Vegas real estate portfolio, the limited partnership
sold the real estate to an unrelated third party and the rental agreement was
canceled. Sierra entered into a 15-year master lease with the third party
purchaser on this real estate. Effective January 1, 2001, Sierra and California
Indemnity have entered into a one-year sublease for the space occupied by
California Indemnity. The sublease is subject to the provisions of Sierra's
master lease and automatically renews from year to year unless California
Indemnity gives notice prior to December 1st of each year.
In September 1998, California Indemnity refinanced a 15-year mortgage note
of an affiliated real estate partnership. Sierra is the majority owner of the
partnership. The note is secured by a first deed of trust and pays interest at
7% per annum. The loan to value ratio was approximately 68%. In December 2000,
in conjunction with a sale-leaseback of Sierra's Las Vegas real estate
portfolio, the mortgage note receivable was paid in full.
In March 2000, California Indemnity financed a $7,400,000 five-year
mortgage note to Sierra. The note is secured by a first deed of trust and earns
quarterly interest payments at 8.75% per annum beginning April 1, 2000 until
April 1, 2005, when the unpaid principal balance is due and payable in full. The
note is callable in April 2001. In December 2000, in conjunction with a
sale-leaseback of Sierra's Las Vegas real estate portfolio, the mortgage note
was assumed by the buyer, the interest rate was increased and the maturity date
was set at December 31, 2001. The buyer can extend the maturity date for two
periods of six months with proper notice to California Indemnity and payment of
additional fees.
In order to make the September 15, 2000 interest payment on the junior
subordinated debentures, Sierra advanced $365,000 to CII Financial, Inc.
13. Quarterly Results of Operations (Unaudited)
The following table sets forth the unaudited data regarding operations for
each quarter of the nine months ended September 30, 2000, and the years ended
December 31, 1999 and 1998. In the opinion of management, such unaudited data
includes all adjustments, consisting only of normal recurring adjustments,
necessary to present fairly the information presented. The Company's operating
results for any quarter are not necessarily indicative of the operating results
for any future period.
Nine months ended September 30, 2000 (in thousands):
3rd Quarter 2nd Quarter 1st Quarter
Net earned premiums $38,263 $27,344 $25,344
Net investment income 3,817 3,571 3,369
--------- ---------- ---------
Total revenues 42,080 30,915 28,713
Costs and expenses 40,832 48,957 25,926
-------- ---------- --------
Income (loss) before income tax and extraordinary
gain 1,248 (18,042) 2,787
Federal income tax provision (benefit) 437 (6,492) 1,153
---------- ---------- ---------
Income (loss) before extraordinary gain 811 (11,550) 1,634
Extraordinary gain, net of tax 93 485 76
----------- ------------ ----------
Net income (loss) $ 904 $(11,065) $ 1,710
========= ======== =======
Year ended December 31, 1999 (in thousands):
4th Quarter 3rd Quarter 2nd Quarter 1st Quarter
Net earned premiums $24,705 $21,860 $18,470 $17,920
Net investment income 3,490 3,788 3,944 4,173
--------- --------- -------- --------
Total revenues 28,195 25,648 22,414 22,093
Costs and expenses 32,952 21,451 18,641 18,211
------- -------- ------- -------
(Loss) income before income
tax and extraordinary gain (4,757) 4,197 3,773 3,882
Federal income tax
(benefit) provision (1,212) 1,679 1,535 1,600
-------- -------- -------- --------
(Loss) income before
extraordinary gain (3,545) 2,518 2,238 2,282
Extraordinary gain, net of tax 109 1 1
---------- --------- ----------- -----------
Net (loss) income $ (3,436) $ 2,518 $ 2,239 $ 2,283
======== ======= ======= =======
Year ended December 31, 1998 (in thousands):
4th Quarter 3rd Quarter 2nd Quarter 1st Quarter
Net earned premiums $24,308 $40,162 $36,978 $32,826
Net investment income 4,511 5,445 5,540 4,733
-------- -------- -------- --------
Total revenues 28,819 45,607 42,518 37,559
Costs and expenses 22,946 40,901 37,896 34,882
------- ------- ------- -------
Income before income
tax and extraordinary gain 5,873 4,706 4,622 2,677
Federal income tax
Provision (benefit) 4,192 (25) (1) ______
------- ---------- -----------
Income before extraordinary gain 1,681 4,731 4,623 2,677
Extraordinary gain, net of tax ______ 45 3 ______
---------- -----------
Net income $ 1,681 $ 4,776 $ 4,626 $ 2,677
======= ======= ======= =======
F-28
CII FINANCIAL, INC. AND SUBSIDIARIES
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS - Parent Company Only
(In thousands)
September 30, December 31,
2000 1999 1998
---- ---- ----
ASSETS (Unaudited)
Cash and cash equivalents $ 83 $ 857 $ 481
Equity in net assets of subsidiaries 104,512 115,002 125,945
Property and equipment, net 1,216 1,621 2,209
Net due from affiliates 936
Other assets 314 568 1,051
------------ ------------ -----------
TOTAL ASSETS $107,061 $118,048 $129,686
======== ======== ========
LIABILITIES AND STOCKHOLDER'S EQUITY
Convertible subordinated debentures $ 47,059 $ 50,498 $ 51,251
Net payable to affiliates 251 3,217
Accrued interest payable 111 1,099 1,117
Accounts payable and accrued expenses 1,377 147 154
----------- ----------- ------------
TOTAL LIABILITIES 48,547 51,995 55,739
---------- --------- ----------
STOCKHOLDER'S EQUITY
Common stock, no par value, 1,000 shares authorized;
shares issued and outstanding - 100 3,604 3,604 3,604
Additional paid-in capital 64,450 64,450 64,450
Accumulated other comprehensive loss:
Unrealized holding loss on available-for-sale
investments of subsidiaries (8,651) (12,200) (702)
(Accumulated deficit) retained earnings (889) 10,199 6,595
----------- ---------- -----------
TOTAL STOCKHOLDER'S EQUITY 58,514 66,053 73,947
---------- ---------- ----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $107,061 $118,048 $129,686
======== ======== ========
CII FINANCIAL, INC. AND SUBSIDIARIES
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
CONDENSED STATEMENT OF OPERATIONS - Parent Company Only
(In thousands)
Nine Months Ended September Year Ended December 31,
30,
2000 1999 1999 1998 1997
---- ---- ---- ---- ----
(Unaudited) (Unaudited)
REVENUES
Net investment income $ 38 $ 1 $ 25 $ 118
Realized gains on investments 294
Other 707 $ 840 1,084 1,323 435
-------- -------- -------- -------- --------
Total revenues 745 840 1,085 1,348 847
--------- --------- -------- -------- --------
EXPENSES
Interest expense 2,725 2,882 3,707 3,997 4,088
General and administrative 523 620 765 897 568
-------- -------- --------- --------- --------
Total expenses 3,248 3,502 4,472 4,894 4,656
------- ------- -------- -------- -------
Equity in undistributed (loss) earnings of
subsidiaries (7,239) 9,701 7,141 17,309 14,062
------ ------- ----- ------ ------
(LOSS) INCOME BEFORE FEDERAL
INCOME TAX (BENEFIT) EXPENSE
AND EXTRAORDINARY GAIN (9,742) 7,039 3,754 13,763 10,253
Federal income tax (benefit) expense (637) 261 51 (288)
-------- ------------ --------- ---------- ---------
(LOSS) INCOME BEFORE
EXTRAORDINARY GAIN (9,105) 7,039 3,493 13,712 10,541
-------- ------- -------- ------- --------
Extraordinary gain from debt extinguishments
(net of income taxes of $353, $0, $59, $25 and $1) 654 111 48 2
---------- ------------ --------- ---------- ------------
NET (LOSS) INCOME $(8,451) $7,039 $3,604 $13,760 $10,543
======= ====== ====== ======= =======
CII FINANCIAL, INC. AND SUBSIDIARIES
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
CONDENSED STATEMENT OF CASH FLOWS - Parent Company Only
(In thousands)
Nine Months Ended
September 30, Year Ended December 31,
2000 1999 1999 1998 1997
---- ---- ---- ---- ----
(Unaudited) (Unaudited)
CASH FLOW OPERATING ACTIVITIES:
Net (loss) income $ (8,451) $ 7,039 $ 3,604 $ 13,760 $10,543
Adjustments to reconcile net (loss) income to net
cash used in operating activities:
Equity in undistributed earnings of subsidiaries 7,239 (9,701) (7,141) (17,309) (14,062)
Extraordinary gain (1,007) (170) (73) (3)
Depreciation and amortization 524 520 721 883 464
Change in assets and liabilities:
Net payable to parent and subsidiaries (1,187) 69 (2,370) 1,126 53
Other assets 134 311 338 (466) 2,040
Accounts payable and accrued expenses 1,231 (428) (7) 374 (2,113)
Interest payable
--------
(988) (961) (18) (78) 3
---------- --------- --- ---------- -----------
Net cash used in operating activities (2,505) (3,151) (5,043) (1,783) (3,075)
--------- -------- --------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures 77 2 (553) 210
-------- --------- --------- --------
------ ------- -------- --------- ---------
Proceeds from sales/maturities of available-for-sale
-------- --------- --------
investments 2,698
------ ------- -------- --------- ---------
Net cash provided by (used in) investing activities
---- --------------------
77 2 (553) 2,908
---------- ------------- - ---------
CASH FLOW FROM FINANCING ACTIVITIES:
Repurchase of convertible subordinated debentures (2,432) (55) (583) (3,143) (27)
Capital contribution 3,665
Dividend to Sierra (2,637)
Dividend from subsidiaries 6,800 3,000 6,000
------ ------ ---------- ---------
Stock option activity
---------
_______ 418 1,737
------ ------ ---------- ---------
Net cash provided by financing activities
------
1,731 2,945 5,417 940 1,710
---------- ---------- ----- ---------- ----------
NET CHANGE IN CASH AND CASH
---------
EQUIVALENTS (774) (129) 376 (1,396) 1,543
---------- ---------- --- ------- ---------
----------
---------- ---------- --- -------- ----------
CASH AND CASH EQUIVALENTS AT
---------
BEGINNING OF PERIOD 857 481 481 1,877 334
---------- ---------- --- -------- ----------
CASH AND CASH EQUIVALENTS AT END OF $
========
PERIOD $ 83 $ 352 857 $ 481 $1,877
========== =========== === ========= ======
No person has been authorized to give any information or to make any
representations other than those contained in the exchange offer and, if given
or made, such information or representations must not be relied upon as having
been authorized. This statement and any related documents do not constitute an
offer to buy or the solicitation of an offer to sell debentures or common stock
in any circumstances in which such offer or solicitation is unlawful. In those
jurisdictions where the securities, blue sky or other laws require the offer to
be made by a licensed broker or dealer, the offer shall be deemed to be made on
behalf of CII Financial by the dealer manager or one or more registered brokers
or dealers licensed under the laws of such jurisdiction.
In order to tender, a holder must send or deliver a properly completed and
signed Letter of Transmittal, certificates for old junior subordinated
debentures and any other required documents to the Exchange Agent at its address
set forth below or tender pursuant to DTC's Automated Tender Offer Program.
The Exchange Agent for the Exchange Offer is:
WELLS FARGO CORPORATE TRUST
By Registered & Certified Mail:
WELLS FARGO BANK MINNESOTA, N.A.
Corporate Trust Operations
MAC N9303-121
PO Box 1517
Minneapolis, MN 55480
By Regular Mail or Overnight Courier:
WELLS FARGO BANK MINNESOTA, N.A.
Corporate Trust Operations
MAC N9303-121
Sixth & Marquette Avenue
Minneapolis, MN 55479
In Person by Hand Only:
WELLS FARGO BANK MINNESOTA, N.A.
12th Floor - Northstar East Building
Corporate Trust Services
608 Second Avenue South
Minneapolis, MN 55479
By Facsimile (for Eligible Institutions only):
(612) 667-4927
For Information or Confirmation by
Telephone:
(800) 344-5128
Any questions or requests for assistance or for additional copies of this
Prospectus, the Letter of Transmittal or related documents may be directed to
the Information Agent at its telephone number set forth below. A holder may also
contact the Dealer Manager at its telephone number set forth below or such
holder's broker, dealer, commercial bank, trust company or other nominee for
assistance concerning the Exchange Offer.
The Information Agent for the Exchange Offer is:
D.F. King & Co., Inc.
77 Water Street
New York, New York 10005
Bankers and Brokers Call Collect: (212) 269-5550
All Others Call Toll-Free: (800) 735-3591
The exclusive Dealer Manager for the Exchange Offer is:
Banc of America Securities LLC
100 North Tryon Street, 7th Floor
Charlotte, North Carolina 28255
Attention: High Yield Special Products
(704) 388-4813 (Collect)
(888) 292-0070 (Toll Free)
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 20. Indemnification of Directors and Officers.
Section 317 of the California Corporations Code authorizes a corporation to
indemnify any director or officer who was or is a party or is threatened to be
made a party to any proceeding (other than an action by or in the right of the
corporation to obtain a judgment in its favor) because the person is or was a
director or officer of the corporation, against expenses, judgments, fines,
settlements and other amounts actually and reasonably incurred in connection
with the proceeding. This indemnification is allowed only if the person acted in
good faith and in a manner the person reasonably believed to be in the best
interests of the corporation. In the case of a criminal proceeding, the person
must have had no reasonable cause to believe his or her conduct was unlawful. A
corporation may advance expenses incurred in defending any proceeding prior to
the final disposition of the proceeding if the corporation receives an
undertaking by or on behalf of the director or officer to repay that amount if
it is ultimately determined that the person is not entitled to be indemnified. A
corporation may also indemnify a director or officer against expenses actually
and reasonably incurred by that person in connection with the defense or
settlement of the action by or in the right of the corporation to obtain a
judgment in its favor. This indemnification is allowed only if the person acted
in good faith and in a manner the person believed to be in the best interests of
the corporation and its shareholders.
The decision of whether indemnification will be provided in a particular
case will be made by (i) a majority vote of a quorum consisting of directors who
are not parties to the proceeding, (ii) if a quorum is not obtainable, by
independent legal counsel in a written opinion, (iii) approval of a majority of
the shareholders, excluding the shares of the person to be indemnified; or (iv)
the court in which the proceeding is or was pending.
Indemnification is not allowed if it would be inconsistent with (i) a
resolution of the shareholders, (ii) the company's articles of incorporation or
by-laws, (iii) an agreement in effect at the time of the cause of action, or
(iv) any condition expressly imposed by a court in approving a settlement.
In addition, a California corporation may obtain and maintain insurance on
behalf of any director or officer of the corporation for any liability asserted
against him or her, whether or not the corporation has the power to indemnify
him or her against liability under the California Corporations Code.
Article 7 of CII Financial, Inc.'s (the "Company") by-laws provide for the
indemnification under certain conditions of directors, officers, employees any
agents acting in their official capacities.
The Company has not entered into separate indemnification agreements with
any of its officers or directors.
The Company has purchased directors' and officers' liability insurance
insuring the Company's officers and directors against certain liabilities and
expenses incurred by such persons in such capacities.
Item 21. Exhibits and Financial Statement Schedules.
(a) Exhibits
Exhibit
Number Description
1 --Form of Dealer Management Agreement
3.1 --Articles of Incorporation of the Company
3.2 --Bylaws of the Company
4.1 --Form of Indenture, of old junior subordinated debentures due 2001 from the
Company to Manufacturers Hanover Trust Company as Trustee dated September 15,
1991, incorporated by reference to Exhibit 4.2 of Post-Effective Amendment No. 1
on Form S-3 to Registration Statement on Form S-4 dated October 6, 1995 (Reg.
No. 33-60591) 4.2 --First Supplemental Indenture between the Company, Sierra
Health Services, Inc. ("Sierra") and Chemical Bank as Trustee, dated as of
October 31, 1995, to Indenture dated September 15, 1991, incorporated by
reference to Exhibit 4.3 of Post-Effective Amendment No. 2 on Form S-3 to
Registration Statement on Form S-4 dated October 31, 1995 (Reg. No.
33-60591)
4.3 --Form of Indenture, of 9% senior subordinated debentures due September
15, 2006 from the Company to Wells Fargo Bank Minnesota, N.A., as Trustee**
4.4 --Specimen 9% senior subordinated debenture due September 15, 2006 of
the Company (included in Exhibit 4.3 hereto)**
5 --Form of Opinion of Morgan, Lewis & Bockius LLP as to the legality of
the 9% senior subordinated debentures due September 15, 2006 of the Company
being registered** 8 --Form of Opinion of Morgan, Lewis & Bockius LLP, special
United States tax counsel to the Company** 10.1 --Credit Agreement dated as of
October 30, 1998, among Sierra as borrower, Bank of America National Trust and
Savings Association as Administrative Agent and Issuing Bank, First Union
National Bank as Syndication Agent, and the other financial institutions party
thereto, dated as of October 30, 1998, incorporated by reference to Exhibit 10.4
to Sierra's Annual Report on Form 10-K filed for the fiscal year ended December
31, 1998 10.2 --First Amendment to Credit Agreement among
Sierra, as
borrower, Bank of America National Trust and Savings
Association as Administrative Agent and Issuing Bank and the
other financial institutions party thereto, dated as of
November 23, 1998, incorporated by reference to Exhibit 10.5
to Sierra's Annual Report on Form 10-K filed for the fiscal
year ended December 31, 1998
10.3 --Second Amendment to Credit Agreement among Sierra as
borrower, Bank of America National Trust and Savings
Association as Administrative Agent and the other financial
institutions party thereto, dated as of January 15, 1999,
incorporated by reference to Exhibit 10.6 to Sierra's Annual
Report on Form 10-K filed for the fiscal year ended December
31, 1998
10.4 --Third Amendment to Credit Agreement among Sierra as
borrower, Bank of America National Trust and Savings
Association as Administrative Agent and the other financial
institutions party thereto, dated as of September 30, 1999,
incorporated by reference to Exhibit 10.7 to Sierra's Annual
Report on Form 10-K filed for the fiscal year ended December
31, 1999
10.5 --Amended and Restated Credit Agreement among Sierra as borrower, Bank
of America, N.A. as Administrative Agent and Issuing Bank, First Union National
Bank, as Syndication Agent and the other financial institutions party thereto,
dated as of December 15, 2000, incorporated by reference to Sierra's Current
Report on Form 8-K dated December 15, 2000 10.6 --Intercompany Services
Agreement dated January 1, 1999, by and between Sierra and California Indemnity
Insurance Company 10.7 --Tax Allocation Agreement dated May 30, 1997, among
Sierra, Health Plan of Nevada, the Company, Sierra Health and Life Insurance
Company, California Indemnity Insurance Company, Commercial Casualty Insurance
Company and CII Insurance Company 10.8 --HCO Contract with Claims Administrator
and Supplement dated January 19, 2001 among California Indemnity Insurance
Company, and each of its insurer subsidiaries, and Sierra Health and Life
Insurance Company.
10.9 --Agreement and Plan of Merger dated as of June 12, 1995 among Sierra,
Health Acquisition Corp., and the Company, incorporated by reference to the
Report on Form 8-K dated June 13, 1995, as amended
10.10 --Guaranty, dated as of August 23, 2000, among the Company, among
others, as guarantors, in favor of Bank of America National Trust and Savings
Association as Administrative Agent and the other financial institutions party
thereto, incorporated by reference to Sierra's Quarterly Report on Form 10-Q
filed for the quarter ended September 30, 2000
10.11 --First and Second Underlying Excess Loss Reinsurance Agreement dated
July 1, 1998, by and between Traveler's Indemnity Insurance Company of Illinois,
California Indemnity Insurance Company, Commercial Casualty Insurance Company,
CII Insurance Company and Sierra Insurance Company of Texas
10.12 --Casualty Quota Share Reinsurance Agreement dated July 1,
1998, by and between Traveler's Indemnity Insurance Company
of Illinois, California Indemnity Insurance Company,
Commercial Casualty Insurance Company, CII Insurance Company
and Sierra Insurance Company of Texas
10.13 --Statutory Workers' Compensation Excess of Loss Reinsurance
Agreement dated January 1, 2000, by and between National
Union Fire Insurance Company of Pittsburgh, Pennsylvania,
California Indemnity Insurance Company, Commercial Casualty
Insurance Company, CII Insurance Company and Sierra
Insurance Company of Texas
10.14 --Workers' Compensation Excess of Loss Reinsurance Agreement dated
July 1, 2000, by and between National Union Fire Insurance Company of
Pittsburgh, Pennsylvania, California Indemnity Insurance Company, Commercial
Casualty Insurance Company, CII Insurance Company and Sierra Insurance Company
of Texas
10.15 --Limited Partnership Agreement of the 2716 N. Tenaya Way Limited
Partnership dated December 3, 1998, among California Indemnity Insurance
Company, Commercial Casualty Insurance Company and Sierra
10.16 --Sublease of 2716 North Tenaya Way, Las Vegas, Nevada, dated January
25, 2001, among Sierra and California Indemnity Insurance Company
10.17 --Intercompany Pooling Agreement dated January 1, 1999, among
California Indemnity Insurance Company, Commercial Casualty Insurance Company,
CII Insurance Company and Sierra Insurance Company of Texas
10.18 --Investment Services Agreement dated January 1, 1999, between Sierra
and California Indemnity Insurance Company 10.19 --Investment Services Agreement
dated January 1, 1999, between Sierra and Commercial Casualty Insurance Company
10.20 --Investment Services Agreement dated January 1, 1999, between Sierra
and CII Insurance Company
10.21 --Investment Services Agreement dated January 1, 1999, between Sierra and
Sierra Insurance Company of Texas
12 --Ratio of Earnings to Fixed Charges
of the Company
21 --Subsidiaries of the Company
23.1 --Consent of Deloitte & Touche LLP
23.2 --Consent of Morgan, Lewis & Bockius LLP (included in the opinions
filed as Exhibit 5 and Exhibit 8)**
24 --Powers of Attorney for the Company (included on signature page
hereof)*
25 --Statement of Eligibility of Trustee on Form T-1
27 --Financial Data Schedule*
99.1 --Form of Letter of Transmittal*
99.2 --Form of Notice of Guaranteed Delivery*
99.3 --Form of Notice of Brokers, Dealers, Commercial Banks, Trust
Companies and other Nominees*
99.4 --Form of Notice to Clients*
- -------------------
99.5 --Form of Company Letter to Debenture holders*
- -------------------
* Previously filed.
**To be filed by amendment.
Item 22. Undertakings.
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii)To reflect in the prospectus any facts or events arising after the
effective date of the registration statement (or the most recent post-effective
amendment thereof) which, individually or in the aggregate, represent a
fundamental change in the information set forth in the registration statement.
Notwithstanding the foregoing, any increase or decrease in volume of securities
offered (if the total dollar value of securities offered would not exceed that
which was registered) and any deviation from the low or high end of the
estimated maximum offering range may be reflected in the form of prospectus
filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than 20 percent change in the
maximum aggregate offering price set forth in the "Calculation of Registration
Fee" table in the effective registration statement.
(iii) To include any material with respect to the plan of distribution and
not previously disclosed in the registration statement or any material change to
such information in the registration statement;
(2) That, for the purpose of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
(4) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
SIGNATURES
Pursuant to the requirements of the Securities Act, the Registrant has duly
caused this Amendment No. 1 to Registration Statement to be signed on its behalf
by the undersigned, thereunto duly authorized, in the City of Las Vegas, State
of Nevada, on the 5th day of February 2001.
CII FINANCIAL, INC.
By /s/ Kathleen M. Marlon
---------------------------------------------
Kathleen M. Marlon
President, Chief Executive Officer and Chairman
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 1 to Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
Signature Title Date
/s/ Kathleen M. Marlon President, Chief Executive Officer, February 5, 2001
- ---------------------- Chairman and Director
Kathleen M. Marlon (Principal Executive Officer)
/s/ John F. Okita Chief Financial Officer February 5, 2001
- --------------------- (Principal Financial
John F. Okita and Accounting Officer)
/s/ Paul H. Palmer Director February 5, 2001
- ---------------------
Paul H. Palmer
/s/ Frank E. Collins Director February 5, 2001
- ---------------------
Frank E. Collins
Exhibit Index
Exhibit
Number Description
1 --Form of Dealer Management Agreement
3.1 --Articles of Incorporation of the Company
3.2 --Bylaws of the Company
4.1 --Form of Indenture, of old junior subordinated debentures due 2001
from the Company to Manufacturers Hanover Trust Company as Trustee dated
September 15, 1991, incorporated by reference to Exhibit 4.2 of Post-Effective
Amendment No. 1 on Form S-3 to Registration Statement on Form S-4 dated October
6, 1995 (Reg. No. 33-60591)
4.2 --First Supplemental Indenture between the Company, Sierra Health
Services, Inc. ("Sierra") and Chemical Bank as Trustee, dated as of October 31,
1995, to Indenture dated September 15, 1991, incorporated by reference to
Exhibit 4.3 of Post-Effective Amendment No. 2 on Form S-3 to Registration
Statement on Form S-4 dated October 31, 1995 (Reg. No. 33-60591)
4.3 --Form of Indenture, of 9% senior subordinated debentures due September
15, 2006 from the Company
to Wells Fargo Bank Minnesota, N.A., as Trustee**
4.4 --Specimen 9% senior subordinated debenture due September 15, 2006 of
the Company (included in Exhibit 4.3 hereto)**
5 --Form of Opinion of Morgan, Lewis & Bockius LLP as to the legality of
the 9% senior subordinated debentures due September 15, 2006 of the Company
being registered** 8 --Form of Opinion of Morgan, Lewis & Bockius LLP, special
United States tax counsel to the Company** 10.1 --Credit Agreement dated as of
October 30, 1998, among Sierra as borrower, Bank of America National Trust and
Savings Association as Administrative Agent and Issuing Bank, First Union
National Bank as Syndication Agent, and the other financial institutions party
thereto, dated as of October 30, 1998, incorporated by reference to Exhibit 10.4
to Sierra's Annual Report on Form 10-K filed for the fiscal year ended December
31, 1998 10.2 --First Amendment to Credit Agreement among
Sierra, as
borrower, Bank of America National Trust and Savings
Association as Administrative Agent and Issuing Bank and the
other financial institutions party thereto, dated as of
November 23, 1998, incorporated by reference to Exhibit 10.5
to Sierra's Annual Report on Form 10-K filed for the fiscal
year ended December 31, 1998
10.3 --Second Amendment to Credit Agreement among Sierra as
borrower, Bank of America National Trust and Savings
Association as Administrative Agent and the other financial
institutions party thereto, dated as of January 15, 1999,
incorporated by reference to Exhibit 10.6 to Sierra's Annual
Report on Form 10-K filed for the fiscal year ended December
31, 1998
10.4 --Third Amendment to Credit Agreement among Sierra as
borrower, Bank of America National Trust and Savings
Association as Administrative Agent and the other financial
institutions party thereto, dated as of September 30, 1999,
incorporated by reference to Exhibit 10.7 to Sierra's Annual
Report on Form 10-K filed for the fiscal year ended December
31, 1999
10.5 --Amended and Restated Credit Agreement among Sierra as borrower, Bank
of America, N.A. as Administrative Agent and Issuing Bank, First Union National
Bank, as Syndication Agent and the other financial institutions party thereto,
dated as of December 15, 2000, incorporated by reference to Sierra's Current
Report on Form 8-K dated December 15, 2000 10.6 --Intercompany Services
Agreement dated January 1, 1999, by and between Sierra and California Indemnity
Insurance Company 10.7 --Tax Allocation Agreement dated May 30, 1997, among
Sierra, Health Plan of Nevada, the Company, Sierra Health and Life Insurance
Company, California Indemnity Insurance Company, Commercial Casualty Insurance
Company and CII Insurance Company 10.8 --HCO Contract with Claims Administrator
and Supplement dated January 19, 2001 among California Indemnity Insurance
Company, and each of its insurer subsidiaries, and Sierra Health and Life
Insurance Company.
10.9 --Agreement and Plan of Merger dated as of June 12, 1995 among Sierra,
Health Acquisition Corp., and the Company, incorporated by reference to the
Report on Form 8-K dated June 13, 1995, as amended
10.10 --Guaranty, dated as of August 23, 2000, among the Company, among
others, as guarantors, in favor of Bank of America National Trust and Savings
Association as Administrative Agent and the other financial institutions party
thereto, incorporated by reference to Sierra's Quarterly Report on Form 10-Q
filed for the quarter ended September 30, 2000
10.11 --First and Second Underlying Excess Loss Reinsurance Agreement dated
July 1, 1998, by and between Traveler's Indemnity Insurance Company of Illinois,
California Indemnity Insurance Company, Commercial Casualty Insurance Company,
CII Insurance Company and Sierra Insurance Company of Texas
10.12 --Casualty Quota Share Reinsurance Agreement dated July 1,
1998, by and between Traveler's Indemnity Insurance Company
of Illinois, California Indemnity Insurance Company,
Commercial Casualty Insurance Company, CII Insurance Company
and Sierra Insurance Company of Texas
10.13 --Statutory Workers' Compensation Excess of Loss Reinsurance
Agreement dated January 1, 2000, by and between National
Union Fire Insurance Company of Pittsburgh, Pennsylvania,
California Indemnity Insurance Company, Commercial Casualty
Insurance Company, CII Insurance Company and Sierra
Insurance Company of Texas
10.14 --Workers' Compensation Excess of Loss Reinsurance Agreement dated
July 1, 2000, by and between National Union Fire Insurance Company of
Pittsburgh, Pennsylvania, California Indemnity Insurance Company, Commercial
Casualty Insurance Company, CII Insurance Company and Sierra Insurance Company
of Texas
10.15 --Limited Partnership Agreement of the 2716 N. Tenaya Way Limited
Partnership dated December 3, 1998, among California Indemnity Insurance
Company, Commercial Casualty Insurance Company and Sierra
10.16 --Sublease of 2716 North Tenaya Way, Las Vegas, Nevada, dated January
25, 2001, among Sierra and California Indemnity Insurance Company
10.17 --Intercompany Pooling Agreement dated January 1, 1999, among
California Indemnity Insurance Company, Commercial Casualty Insurance Company,
CII Insurance Company and Sierra Insurance Company of Texas
10.18 --Investment Services Agreement dated January 1, 1999, between Sierra
and California Indemnity Insurance Company 10.19 --Investment Services Agreement
dated January 1, 1999, between Sierra and Commercial Casualty Insurance Company
10.20 --Investment Services Agreement dated January 1, 1999, between Sierra
and CII Insurance Company
10.21 --Investment Services Agreement dated January 1, 1999, between Sierra and
Sierra Insurance Company of Texas
12 --Ratio of Earnings to Fixed Charges of the Company
21 --Subsidiaries of the Company
23.1 --Consent of Deloitte & Touche LLP
23.2 --Consent of Morgan, Lewis & Bockius LLP (included in the opinions
filed as Exhibit 5 and Exhibit 8)**
24 --Powers of Attorney for the Company (included on signature page
hereof)* 25 --Statement of Eligibility of Trustee on Form T-1
27 --Financial Data Schedule*
99.1 --Form of Letter of Transmittal*
99.2 --Form of Notice of Guaranteed Delivery*
99.3 --Form of Notice of Brokers, Dealers, Commercial Banks, Trust
Companies and other Nominees*
99.4 --Form of Notice to Clients*
- -------------------
99.5 --Form of Company Letter to Debenture holders*
- -------------------
* Previously filed.
**To be filed by amendment.